When creating or expanding a business, there are many moving pieces to keep in mind when it comes to reporting income to the Internal Revenue Service (IRS). Even more intimidating is navigating the intricacies of incorporating, especially understanding the different types of corporations.
Each classification of a corporation has its own set of requirements as well as distinct advantages and disadvantages that apply to companies at different points in their lifespan. The principal differences between the types of corporations lie within the distinct tax codes applied to each of them. Choosing the right type depends on many characteristics of your company, namely its size and structure.
Here, we determine whether a particular type of corporation, an S corporation, is the right move for you and your company.
What are the requirements associated with a S corporation?
The IRS has a specific list of conditions that must be met for a business to classify itself as an S corporation. The first stipulation relates to the size of a company stating it must have less than 100 shareholders, all of which must be a citizen of the U.S. or meet the green card or substantial presence test. Additionally, the business must be incorporated domestically and boast only one type of stock.
What are the advantages of a S corporation?
The first and foremost advantage of becoming a S corporation is having the option of designating generated income as distributions or salary, decreasing their liability for self-employment taxes. This status can also benefit shareholders as those who are employees can enjoy tax-free distributions as long as this does not exceed the value of their stock basis. If it does, it will simply be taxed as capital gains at lower rates than typical income.
S Corporation status can also save money on corporate taxes by not being required to pay federal taxes at the level of an entity. This is especially beneficial to companies in the early stages of their development as they can reinvest more money into their business. Secondly, a small business upgrading to becoming a S corporation demonstrates a reliable amount of dedication on the part of an owner to the company, benefitting the perception of potential clients and investors.
What are the disadvantages of a S corporation?
The IRS is very strict about the company reasonably paying its employees, especially employees who are also shareholders. The company must also allocate profits according to the percentage of shares that each individual shareholder possesses. Those who violate this allocation stipulation face termination of their S status.
Becoming an S corporation through the process of incorporating can be a very costly endeavor and it is important to treat this as an investment, weighing how much upgrading to this status could save the company versus how much it will cost to obtain this status.
Lastly, the limit on the number of shareholders contains the potential of limiting a business that is looking for as much capital and as many investors as possible.
Converting your company into a S corporation can be a slow and meticulous process. Here at the Hechtman Group, we know that time is of the essence when preparing for such a transition. Contact us today to discuss whether becoming an S corporation is right for you. Upon first contact, we begin our process of supporting you and your tax and accounting needs every step of the way.
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