When it’s time to legally open a business, many people wonder whether they should register an S-Corp or an LLC. Well, nowadays LLCs are by far the most popular type of business entity. But don’t discount the good ‘ol S-Corp, there’s still certain situations where it’s your best choice.
First of all, what is an S-Corporation?
An S-Corp is a special type of corporation created through an IRS tax election. Ever heard of Form 2553? S Corps are the corporations that have filed Form 2553, which is commonly known as the “S Election”. Having your S Election filed will tell the IRS that you’d like your corporation to be taxed as defined in the Subchapter S of the Internal Revenue Code. Confused yet?
Check out some of the requirements to becoming an S-Corp:
- Being an American corporation (I guess this is a no-brainer)
- Having 100 or less shareholders
- Having a single and class of stock
- Not being an ineligible corporation (like certain financial institutions, insurance companies, and domestic international sales corporations)
Ok, so let’s say you’ve decided to go for an LLC (perhaps the S-Corp isn’t really for you), but you wished your corporation was taxed as an S-Corp (after all, the S-Corp taxation model has its benefits). Well I’ve got great news – you can have it, the best of both worlds! All you have to do is fill out that same S Election form (2553) I’ve mentioned previously.
Tell me more about how the taxation works…
Being taxed as an S-Corp definitely has some pros, and the main one is probably that the self-employment tax burdens are reducible. So if you don’t work for someone else you’ll have to pay both portions of taxes (employer and employee), but if you set it up so you get taxed as an S-Corp, those taxes can be lower. Amazing, right?
To exploit the benefits of having an S-Corp taxing status, a salary must be paid to the business’s owner. If your business does not have employees, the S Election form might not be your best option, or even be legal.
Let’s sum it up…
Hopefully you can see by now that S-Corps are pass-through entities … which means the corporation is not liable for federal income tax. The shareholders are then taxed according to their allocated share of the income. So yes, there are plenty of benefits to an S-Corp, but if you’re leaning towards an LLC, you can still take advantage of the benefits of S-Corp taxation. This page has a great comparison table on the different business entities.