What is an S Corp? Subchapter S Corporations is one of the most misunderstood concepts in business law.
What is an S Corp?
S Corps are entities who have chosen the subchapter S tax rules and regulations opposed to their default options. Both LLCs and corporations can make this election. However, there are many criteria to qualify.
First, ownership must be entirely non-entity US citizen owners. This means no LLCs or corporations owning any portion of the company.
Second, profits and losses must be divided in proportion to ownership. If a person owns 25% of the company, he or she gets 25% of the profits and losses.
Third, an S Corp may not have more than 100 owners. If, at any point, there are more than 100 owners, the company loses its tax election. This means, for that year, the company will have its default tax treatment.
Fourth, you may only have one class of stock. This may put a limit on investment opportunities into your company. In most small businesses, this limitation does not matter.
Now that we’ve covered the limitations, why would anyone want this election?
This tax election is a hybrid between corporate and partnership taxation where you can pass through certain tax consequences through to the shareholders. However, the real benefit comes with paying yourself equity payments opposed to income. This can result in very large tax savings.
Whether or not the S Corp election is right for you is a question for your tax professional. Because there is no one right answer, it is important that you run the calculations or speak with a tax professional about your specific situation.
To obtain this tax election, you need to file Form 2553 with the IRS during the first two months and 15 days of any tax year for the company.
Richard is the managing attorney for Law Plus Plus, a local small business law firm. As managing attorney, he helps small businesses and nonprofits startup, creating the contracts, and navigate the legal needs of businesses. Some of his practice areas include: corporate, contract, mergers & acquisitions, corporate litigation, and estate planning.