What is an S-Corp and Why Should I Use it With My Small Business?

For businesses both large and small, federal taxes can be costly. The IRS allows businesses several ways to minimize losses and maximize gains for businesses and their shareholders. One way to prevent your shareholders from having to file double taxes on the income they've earned from your company is to file as an S Corporation (S-Corp). What is an S-Corp? When a business files under an "S" designation with the IRS, it is filing under subchapter S of the IRS's tax code. Unlike C Corporations, which are taxed separately from owners and shareholders, S-Corps run all income and losses through shareholders at tax time, leaving the S-Corp out of paying taxes altogether. This allows a corporation to act similarly to a partnership, where owners absorb the tax burden instead of the corporation. An S-Corporation is still a legal corporation. It simply separates the corporation from its shareholders. Why File as an S-Corp? S-Corps are separate from their owners, protecting them from personal liability. Any legal action against the corporation is conducted separately, protecting owners' personal assets. This is huge for business owners, who have a vested interest in keeping their homes and families safe. In recent years, the Limited Liability Corporation (LLC) has replaced the S Corporation as the tax status of choice for business owners wishing to protect their personal assets. An S Corporation can have no more than 100 shareholders, so larger companies with more than 100 shareholders will be directed toward an LLC. In an S Corporation, your profits will be divided among shareholders according to ratio of shares, whereas in an LLC you control how you distribute profits. However, with an LLC, you as the owner are considered self-employed. Because of this, you'll be required to pay self-employment taxes of as much as 15.3% on all earnings. Your business will pay self-employment taxes, which go to social security and Medicare, as well. By filing as an S-Corp, you can avoid paying those taxes, paying self-employment tax only on your personal earnings from the business. If you choose to file as an S-Corp, you will be required to pay payroll tax. This is tax that must be paid throughout the year to avoid IRS penalties, so keep this in mind. Not only will the ongoing paperwork increase your work burden, you'll have to pony up money for taxes throughout the year. This can be a problem for businesses that aren't regularly seeing a profit. As a word of warning: the IRS will carefully watch the salary you pay yourself as an owner of the type of business you are running. You will expect to pay yourself, and be taxed on, a reasonable salary for someone in your industry, so resist the temptation to pay yourself a paltry salary of $10,000 a year to save on self-employment taxes. If a business files as a C Corporation, both the business and its owners take a hit at tax time. The business is taxed on its assets and the owners are taxed personally on those assets once they are distributed to them personally. An S Corporation avoids all taxes completely, with assets being taxed as they are distributed to the owners. Do I Qualify as an S-Corp? According to the IRS, in order to qualify for S Corporation status, a business must be located in the United States and doing business in the state in which it is incorporated. Each of the company's shareholders must meet IRS requirements, including having legal resident status. Corporations and partnerships cannot be included among shareholders. To qualify as an S Corporation, you need to have 100 shareholders or less and one class of stock. Certain companies, like financial institutions, insurance companies, and international sales corporations based in the U.S. are not able to file S Corporation status. If you are in doubt about your ability to file S Corporation status, consult a tax professional. For businesses looking to save money with the IRS each year, S Corporation status may be the best way to file without incurring taxes on both the corporate income and monies received personally from that income. As an owner of a small business, S Corporation status may be perfect for you.