An S corporation is a corporation that has decided to choose “S corporation” treatment on their taxes. An S corporation has the limited liability of a corporation but pays their income taxes as a sole proprietor or a partner.
In a regular corporation, or C corporation, the company is taxed based on their profits. The owners themselves only pay income tax on whatever they might receive in the form of bonuses, salaries or dividends.
An S corporation, on the other hand, has business profits pass through directly to the owners. The owners then pay taxes on them at their individual rates. The S corporation does not pay any income tax. An S corporation with more than one owner must file an informational tax return but does not owe any taxes apart from what the individuals must pay.
Texas does not tax an S corporation like a regular or, “C” corporation. Some states do, however, so it is necessary to be very aware of the consequences in any particular state where one does business.
Choosing to be an S corporation has several advantages:
- Taxes are typically less at the time of sale.
- An S corporation allows an individual to pass business losses through to their personal income tax return. It can be used to offset any income that they have from other sources.
- S corporation shareholders are not subject to self-employment taxes which typically add up to more than 15% of income.
However, in order to gain these benefits, there are strict rules that must be followed.
- Every shareholder must be a U.S. citizen or resident.
- There is a limit of 100 shareholders.
- S corporations may not deduct the costs of certain benefits given to employee-shareholders that own more than 2% of the corporation.
- Profits and losses must be distributed in proportion to each shareholder’s business interest.
Due to the fact that “S Corporations” generally have more rules than a Limited Liability Company many business choose to be an “L.L.C.” instead of an “S Corporation”. However, in states that do not allow an “L.L.C.” an S corporation can be a wise choice for a business that wants to limit their liabilities.
Regardless what type of business entity one chooses, it is an important decision. One should make sure that they make a good decision for their business and also that they follow all applicable rules and regulations.