An S corporation combines the limited liability protection of C corporations with the taxation benefits of a sole proprietorship, partnership or LLC. Some states, such as New York and New Jersey, do not recognize S corporation status and treat them like a C corporation. To learn about different business structures, check out our video series on choosing the right business entity for you.
A corporation must meet all of the following requirements to be eligible for IRS S corporation election:
- Must only have one class of stock.
- Must not have more than 100 shareholders.
- All of the shareholders must be U.S. citizens or U.S. permanent residents.
- All of the shareholders must be natural persons (i.e. other corporations, LLCs and partnerships are generally excluded).
- Profits and losses must be allocated to shareholders proportionately to their ownership interests.
Check out the video below for a quick overview of S corporations, and continue reading for more info.
What Are the Benefits of S Corporations?
The benefits of S corporations include:
- Limited liability: If corporate formalities are followed, shareholders will not be personally liable for the debts and obligations of the S corporation beyond their initial investment.
- Preferable tax treatment: Business profits and losses “pass through” to each shareholder’s individual tax return, meaning they aren’t subject to the double taxation of C corporations.
- Reduced self-employment taxes: If shareholders also work for the business, they could enjoy reduced self-employment taxes.
Why Should I Think Twice About S Corporations?
S corporations do have some disadvantages, such as:
- Strict corporate formalities: Among other requirements, S corporations must have annual directors meetings, annual shareholders meetings, maintain corporate minutes and maintain a separate bank account.
- Costly and tedious to set up: You have to file forms with your state and shell over a few hundred dollars to get started. You also have to elect S corporation status with the IRS.
- Ownership restrictions: Only natural persons can be shareholders with maximum of 100, which could be troublesome if the business wants to bring in investors or go public.
S Corporations: The Best of Both Worlds
If you are interested in creating an S corporation, read our step-by-step guide. For a general summary of different business entities, see our video series on the different types of business structures.