What is an S Corporation
Before deciding on the type of corporation one must go for while starting a new business, it is very important to consider and know thoroughly the aspects of the types of corporation. The Internal revenue Service has recognized two types of corporations for the purpose of federal income taxation. They could be a C Corporation or an S Corporation. A C corporation generally refers to the business type which is treated as an independent legal entity for purposes of taxation which means the owners and shareholders are not liable for the losses of the corporation. The profits and losses of the c corp. are taxed separately as corporate tax.
An S corporation on the other hand is a business entity, which doesn’t have to pay federal taxes on profits and thereby eliminating corporate tax. Instead the corporation’s profits, losses, credit and deductions are passed on to the shareholders who are further taxed for receiving the share of profits from the business and thereby pay individual income tax by filing returns. The profits are taxed under the Internal Revenue Code under subchapter S. But there are few eligibility criteria that need to be fulfilled by a business entity to be recognized as an S corporation. Let’s take a glance at them.
- The very first requirement, to get the status of S corporation is that, it has to be an eligible business entity recognized as a corporation, by law.
- It has to be only a domestic corporation.
- The said business entity should have only one class of stock.
- The number of shareholders in the entity should not exceed 100.
- The entity should not be one of the ineligible corporations like a possessions corporation or an insurance company which is subject to be taxed under subchapter L or a domestic international sales corporation.
- The corporation should comprise of only allowable shareholders that includes individuals, estates or certain trusts and does not include partnerships or non-resident alien shareholders.
- Finally each shareholder of the said corporation must accept to get the status of an S corporation.
Now let’s try and understand the benefits of an S Corp
- The most important advantage of an S Corporation is that it could eliminate double taxation thereby corporate tax is avoided.
- While selling a business with S corporation status, the taxable gains are fairly reduced.
- In contrast to a general corporation, an S corp. allows to write off all the initial expenses of starting the business as personal income.
- The liabilities are offers protection in a S Corp which ofcourse doesn’t include the liabilities due to personal actions.
S Corporations are not free of drawbacks which includes the following-
- The organization is limited in issuing only one class of stock.
- The limitation on number of shareholders will not be a favorable attraction for outside investors.
- Filing of tax return is anyway compulsory to be done every year inspite of avoiding corporate taxes.
- The status os S Corp doesn’t withdraw the requirements of holding meetings at regular intervals and maintaining the minutes of company.