Are you about to start your business in the USA but are not sure of S corporation is the one for you? Well, in the USA, an S corporation is the best choice that many small startups select and eventually become successful with. It is like the lite version of the C corporation. So, if you are thinking about choosing the S corporation business entity type, then you are going with the right choice.
Basically, seeing your small business and succeed in a great empire is a dream that many entrepreneurs have. But what you do not know is that as your company grows, so does the tax rate grow. In fact, the companies that grow usually face many complexities at the tax season time. And due to this, it is better to form an S corporation, which is also called an S corp.
Just to mention, an S corporation offers perpetual existence, investment opportunities, along with the desired protection of limited liability. Additionally, the S corporations have to pay taxes yearly where they are not subjected to any double taxation issues that a C corporation suffers from. This article will help you understand all about the S corporation and why it is the right choice for your company.
Note: If you have already registered your company as a C corporation, you can easily convert it into an S corporation. So, do not be disheartened and keep reading to know more and see if it is a wise choice for you to convert it into an S corporation. In fact, you cannot become an S corporation without registering as an LLC or a C corporation with the government first. Not clear with this? Keep reading!
Before we can talk about how you can become an S corporation, let us first understand what an S corporation is all about.
An S Corp, also known as an S corporation, is a business entity type that offers a lot of important tax benefits as it preserves your ownership flexibility. The S corp is also called the subchapter or small business corporation. It was a tax code that was incorporated into the law by Congress in 1958. The S corporation was created to support and encourage the creation of family and small businesses while it eliminated the double taxation issue that the conventional corporation (C corporation) suffers from.
How do you become an S corporation?
For you to own an S corporation, you will first have to register your company as a C corporation or an LLC. There are three simple steps that you will need to follow for your company to become an S corporation. They include:
Step 1: Register as a C corp or an LLC
For you to be able to elect your corporation as an S corporation, you will have to register it as a C corporation which is a regular corporation. Once you incorporate your company as a C corporation through your state, you will have to elect for the S corporation status with the federal government. On the contrary, you can also elect to be an S corporation if you are an LLC and meet the criteria of the IRS.
Step 2: Ensure that You Qualify for S Corp Status
Not every kind of C corporation can become an S corp. So, before you apply for converting into an S corp, you will have to see if you are eligible. For that, you will need to satisfy the following shared requirements:
- It has to be a domestic corporation that is operated and based in the USA.
- Every shareholder in the company has to approve of the S corporation status change.
- The company cannot be domestic international sales corporation, a bank or an insurance company.
- The corporation should only have one class of stock.
- There cannot be more than 100 shareholders in total for the company.
- The shareholders in the company should be “allowable” shareholders, which means that none of them should be non-resident shareholders, other corporations, and partnerships.
Once you see that you are eligible as per these rules, you can then move ahead and go to the next step to file for the status.
Step 3: File the Form 2553
After the eligibility has been checked, you have to fill the Form 2553 and submit it to the IRS. This form is called the Election by a Small Business Corporation and it has to be signed by all the shareholders in the company. The IRS will then check everything and if all is well, you will get the update of your corporation’s status change.
But if you still wondering what is the difference between an S Corp and a C Corp, or an S corp and an LLC, keep reading to know better. In fact, you will be able to understand better regarding if converting into an S corporation is a good choice for your company by the following.
S Corp Vs C Corp
An S corporation is a lite version of a C corporation. Any business that files for becoming a corporation is classified as a C corporation. As soon as the company is incorporated as a C corp, and they meet the requirements of an s corp, they can choose to get the S corporation status.
Here are the main differences between an S corporation versus a C corporation:
Taxes are one of the main reasons why people choose an S corp over a C corp. In fact, there is a huge difference between the S corporation and C corporation federal taxes. To explain better, a C corp has to pay the corporation tax return on the profits the company has earned. And once the profits are distributed to the shareholders, the dividends are taxed at the personal level. In short, the profits earned by the C corp are taxed twice and at two different levels.
This thing can only be avoided by electing the S corporation status for the C corporation. The S corp is treated as a partnership or sole proprietorship and the profits are only taxed at a personal level through the shareholder’s personal tax return.
The C corporation would offer more flexibility in terms of selling the shares of the company. But this is not the case for the S corporation. There are a lot of restrictions for an S corp. The restrictions include:
- The S corp cannot be owned by other S Corporations, C Corporation, partnerships, LLCs, or various trusts.
- It should have shareholders who are US citizens or residents.
- The company cannot issue more than one class of stock.
- It cannot have more than 100 shareholders in total.
All these above-mentioned restrictions are not the same for the C corporation. Instead, with a C corporation, you can easily grow your company and turn it into an empire. With an S corporation, it is not like this. S corporation status was designed for the small companies and not for large empires.
If a company wants to offer fringe benefits to the shareholders who are employees of the company like the disability, life or health insurance, the cost of these benefits can be deducted by a C corp and not by an S corporation. Moreover, the shareholder too does not have to pay any tax on them if they are a part of a C corporation. On the other hand, with the S corporation, none of the cost benefits can be deducted. Everything is taxable for both the shareholder and the corporation.
S Corp vs LLC
Just like C corporation, a business will have to first register as an LLC and then can be converted into an S corporation. But an LLC is a business entity that is separate from the owners, who are called the “members” of the LLC. Moreover, an LLC can have one or more members. And due to this, a lot of small business owners choose to form an LLC instead of a corporation due to its flexibility to manage it.
In fact, an LLC has very little reporting and record keeping obligations as compared to corporations. But on the other hand, an S corporation is not like this. S corporation has just one benefit which is that it is not subjected to double taxation. Other than that, it does not have such benefits that the LLC has. The following will help you understand better the differences between both.
Under the tax part, the IRS classifies all businesses as either partnerships, C corporations, sole proprietorships, or S corporations. There is nothing called LLC under the tax classification. And that is why an LLC is taxed as though it is another kind of business. By default a single-member LLC is taxed as a sole proprietorship and a multi-member LLC is taxed as a partnership.
But an LLC can also choose to be taxed as a C corporation or as an S corporation. And in both ways, the shareholders are the ones who pay the taxes through their personal income tax return after they are distributed their share of dividends from the company.
How to form an S Corp?
Now that you know what an S corporation is and what makes it different from the rest, let us understand how to form one. Here are the following steps to form an S corporation:
- Select the legal name for your business and have it reserved (if your state does it since not all states require you to reserve your company name before incorporating it).
- Next, file your Articles of Incorporation with your Secretary of State.
- Issue the share certificates to the founders and the first shareholders of the company.
- Get the business license and any other needed certificates for your company.
- Get the Employer Identification Number (EIN) by applying online on the IRS website or filing the Form SS-4.
- If there is any other ID that you need from the state or local government, apply for it before you begin your business.
- Once 75 days have passed since your company was formed and business started, you can file the Form 2553 for electing the S corporation status.
And with this, you will have an S corporation and would pay taxes according to it.
How can IncParadise help you?
With all this clear, the next thing you need to do is register your dream business. And for this, IncParadise can help you. We offer you all the services that you need for starting your business in the USA. Contact us today to have your company registered and incorporated!