Should You Choose S Corporation Status?

August 27, 2011

Deciding what type of business company structure is best for your small business can be as complicated as it is important.     Most business owners have two main goals when choosing a structure for their business: protecting their personal assets from claims and having the ability to have their business profits taxed on individual tax returns. This makes S corporations an excellent option.  The IRS defines S corporations as corporations that elect to pass corporate income, losses, deductions, and credit through to their shareholders for federal tax purposes.   Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on their corporate income.

Should you choose S Corporation Status?

Operating as an S corporation may be advantageous for a number of reasons.  Forming an S corporation generally allows you to pass business losses through to your personal income tax return, where you can use it to offset any income that you (and your spouse, if you’re married) have from other sources.  If or when you sell your S corporation, your taxable gain on the sale of the business can be less than it would have been had you operated the business as a regular corporation.   S corporation shareholders are not subject to self-employment taxes (as LLC owners are). These taxes, which can amount to more than 15% of income, are used to pay Social Security and Medicare taxes.

To qualify for S corporation status, the corporation must meet the following requirements:

  • Be a domestic corporation
  • Have only allowable shareholders
    • including individuals, certain trust, and estates and
    • may not include partnerships, corporations or non-resident alien shareholders
  • Have no more than 100 shareholders
  • Offer only 1 class of stock
  • Not be an ineligible corporation i.e. certain financial institutions, insurance companies, and domestic international sales corporations.

In order to become an S corporation, the corporation must submit Form 2553 Election by a Small Business Corporation signed by all the shareholders.

The IRS  provides a wealth of tax information on its Small Business and Self Employed Tax Center.  Most tax and accounting firms can also provide guidance on the type of business formation right for you. It is critically important for owners of small businesses to closely follow tax developments on the federal and state level. Tax law changes have the potential to affect the tax treatment of their particular business entity, including S corporations.  You should always consult your Hollywood tax and accounting professional to with questions about tax advantages of a corporation, and to stay current with tax law changes affecting your business.