In this article, we’re answering “What is an S Corporation?” In short, an S Corp is a type of business entity that is used in the United States.
In the sections below, we will dig into the specific benefits offered by S Corps. We will also discuss how S Corps compare to LLCs. And, we’ll explain the specific criteria you need to pass to form an S Corp.
As always, if you are looking to make a decision on the type of business structure that is best for you, you should consult with a qualified professional to ensure you make the best choice possible.
This article is part of our free series on corporate banking solutions and features, which you can access by clicking here.
Feel free to use the table of contents to jump ahead to the sections most relevant to you.
Table of Contents
- What Is an S Corporation?
- Advantages of S Corps
- S Corporation vs Limited Liability Company
- How to Form an S Corporation
- Frequently Asked Questions
- Do You Want Help Opening Bank Accounts?
What Is an S Corporation?
An S Corporation (S Corp) is a type of business entity that combines limited liability protection with certain tax advantages. In order to qualify as an S Corporation, an entity must pass all “tests” set forth by the IRS and complete the S Corporation election by completing and submitting Form 2553.
One of the main advantages of the S Corporation election is the benefit of pass-through taxation. In short, an S Corporation is not liable for tax as the burden of taxation is passed to the shareholders of the corporation.
Additionally, the other common benefits associated with the incorporation of a business structure through the formation process still hold true. These benefits include liability protection, professionalism, separation of personal and business activities, and ease of transferability.
In the following sections, we will look at the advantages and disadvantages of an S Corporation, including considerations for double taxation, shareholder compensation, and much more.
Advantages of S Corps?
The main advantages of S Corps, as mentioned, relate to taxation and liability protection. In particular, the S Corporation election results in the company being treated as a pass-through entity while still maintaining a separate legal entity.
Of course, as a separate legal entity, the S Corporation also allows businesses to operate, incur expenses, offer employees health and retirement plans, and more.
And, in addition to these advantages, an S Corp allows business owners that work in the business to avoid some of the self-employment tax by taking shareholder distributions on a portion of the funds that they receive.
With the above in mind, you might be wondering “How does an S Corporation compare to a Limited Liability Company (LLC)?” We’re discussing this next.
S Corporation vs Limited Liability Company
The main difference between an S Corporation and a Limited Liability Company includes the type and number of shareholders allowed in each entity. S Corporations can have a maximum of 100 shareholders, they must be residents of the United States, and they cannot be other corporations. On the other hand, a Limited Liability Company can have unlimited shareholders and both natural persons and other corporations can be shareholders.
There are also differences in the form of governance and management that both S Corporations and Limited Liability Companies can choose. For example, an S Corporation must hold regular shareholder meetings, keep minutes and bylaws, and generally has more formalities that it needs to follow. Comparatively, Limited Liability Companies are not required to hold regular meetings and do not have nearly as many formalities as S Corps.
How to Form an S Corporation?
The first step in forming an S Corporation is to form a business entity in the United States. This requires the shareholders to choose a name for the business, select a state for incorporation, appoint directors and officers, and file articles of incorporation.
After a company is formed, it needs to obtain an Employer Identification Number (EIN), create bylaws, issue stock, and hold a shareholder meeting. Then the corporation can proceed with filing Form 2553 with the IRS, which is the Election by a Small Business Corporation. Or, as it is more commonly known, the S Corp election.
However, as mentioned above, in order to qualify for S Corp election, a business must meet certain tests set forth by the IRS, which include the following.
- Must be a domestic corporation (or entity)
- Have less than 100 shareholders
- Shareholders are individuals and estates (no corps)
- All shareholders are residents of the United States
- Only one class of stock has been issued
- It is not an ineligible corp (e.g. bank, insurance, DISC, etc.)
- The tax year ends Dec 31 (or an accepted alternative)
- Each shareholder consents to the S Corp election
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Frequently Asked Questions
Below are a few of the most common questions we receive from people looking into what an s corporation is. If you have further questions you would like to ask our team, don’t hesitate to get in touch.
What Is the Difference Between an LLC and S Corporation?
The main differences between an LLC and an S Corporation are that an LLC can have unlimited shareholders, shareholders can be corporations, an LLC is not required to hold regular meetings, and LLCs are generally less tightly regulated than S Corporations. On the other hand, an S Corporation can have up to 100 shareholders, shareholders must be individuals or estates, they are required to hold regular meetings, and have more formalities that they need to follow in how they are governed and managed.
Why Would a Company Be an S Corp?
A company would be an S Corp in order to capture specific benefits related to taxation, employee benefits, shareholder distributions, or one of the other many benefits that an S Corporation can offer business owners.
Can a Single Member LLC Be an S Corp?
Yes, a Single Member LLC can elect to be an S Corp. However, this is only possible if the LLC meets the specific tests set forth by the IRS. In particular, is the single member of the LLC a resident of the United States or a non-resident of the United States? If they are a resident, the LLC may qualify.
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