As an entrepreneur starting your business, you may be hearing a lot of buzz about the “S-corp.” A basic corporation is often referred to as a “C-corp”; an S-corp is simply a C-corp that elects to be taxed under Subchapter S of the Internal Revenue Code. What does this mean, exactly? The main advantage of electing to be taxed as an S-corp is that the corporation will pass income through the corporation and onto its shareholders. As opposed to a C-corp, which pays taxes at the corporate level, an S-corp itself does not pay taxes, but its shareholders do.
This can be an advantageous situation for startups because it reduces tax liabilities at a critical time in the business’s young life. Like income, losses will also pass through to shareholders (which, for a young startup, typically means founders). This is an extremely desirable situation because these losses can be offset against income from the business, thereby reducing your total tax liability. The S corporation also allows shareholders to receive dividends, which taxed at the capital gains rate, typically far more favorable than the rate at which income is taxed.
So, the S corporation sounds like a no-brainer, right? As with everything, there are downsides. While the S-corp is a pass through entity, it’s similar in many ways to an LLC. But buyer beware: because it’s still a corporation, an S-corp has to hew to stricter legal formalities than an LLC. Some of these formalities could include paying state report fees, creating corporate bylaws, issuing stock, and keeping more detailed books and records. Additionally, S-corps have limitations on stock that can be issued. Unlike C-corps, S-corps can’t issue more than one class of stock (that means no preferred shares). Additionally, the S-corp may only have up to 100 shareholders. Finally, the IRS tends to keep a more watchful eye on S-corps, since shareholders can receive both dividends and a salary.
Is an S-corp for you? There’s no pat answer; it depends on what you’re planning to do with your business and what your short- and long-term goals are. Contact us today to speak with an attorney about the best structure for your business.