entrepreneur

S-Corps are corporations that elect to pass corporate income, losses, deductions, and credits through to their owners (“shareholders”) for federal tax purposes.

Articles of incorporation must be filed with the state to create your business entity. Then, corporations wishing to be taxed as S Corps must file Form 2553 with the IRS.

What is it?

S-Corps are corporations that elect to pass corporate income, losses, deductions, and credits through to their owners (“shareholders”) for federal tax purposes.

Note: The most common question I hear about S-Corporations concerns what the “S” stands for. There is a misconception that it stands for “small,” as many small business choose to set up as an S-Corp. Rather, S-Corps operate under Subchapter S of Chapter 1 of the Internal Revenue Code. By contrast, C-Corporations operate under Subchapter C of Chapter 1.

How do I do it?

Articles of incorporation must be filed with the state to create your business entity. Then, corporations wishing to be taxed as S Corps must file Form 2553 with the IRS.

Pros:

• The owner of an S-Corp could reduce his or her Self-Employment and Medicare Tax liability if work as an employee of the entity.
  • A reasonable salary can be paid out of the S-Corp – reported to the shareholder/employee on a Form W-2.
    • This amount is reported on the recipient’s Form 1040 for the year.
    • The recipient owes Self-Employment and Medicare taxes on this amount
  • Additional income to the S-Corp also passes through to the shareholders. This amount is calculated after salaries to employees are paid. This S-Corp income is reported to the shareholder on a Form K-1.
    • This amount is also reported on the recipient’s Form 1040 for the year, but there is no Self-Employment or Medicare tax requirement for income from a Form K-1.

Cons:

• S-Corps can be more difficult to set up and maintain as they require the same governance as a “C” – corporation.
• Some states charge S-Corps an additional franchise tax, so check local laws prior to establishment.

Tax Considerations:

• S-Corps report annual income and loss on a Form 1120S (generally due March 15).
• S-Corps must complete Forms K-1 for all shareholders reporting their individual share of income and loss for the year.
  • One copy of the Form K-1 is filed with the Form 1120S.
  • The other copy of the K-1 is sent to the shareholder who will report his or her share of income and/or loss on his or her personal income tax return.
• While stock issuance is generally not an initial concern of small business owners looking to incorporate, legally, an S-Corp can have only one type of stock limited to not more than 100 shareholders.
  • There are additional state limitations, so check carefully if you think stock will play a part in your company’s future.
• Incorporation is not free, so weigh the cost (both initial filing cost and cost of any required annual updates or filings) appropriately.
• The limited liability discussed above will not protect you from personal negligence. You are not shielded from your own misconduct by your incorporation.