An S-corporation is a special corporate structure which provides the legal protection of a traditional corporation to a business, while also minimizing tax obligation.
Like a sole proprietorship or partnership, S-corporations pass corporate income, losses, credits, and deductions through to shareholders for federal tax purposes. These shareholders report the profits and losses on their personal tax returns and are assessed at their individual rates of taxation. But like an LLC, the personal assets of these owners cannot be seized to pay business debts.
S-corporations have distinct advantages, some of which are outlined below.
Enhanced credibility
When it operates as an S-corporation, a new business may enjoy greater credibility with banks, vendors, and customers, as incorporation is taken as a sign of formal commitment to the business.
“Pass-through” taxation
On the corporate level, an S-corporation does not pay federal taxes. (In California, however, they are subject to a 1.5% state tax on any net profits, provided there is an $800 minimum.) The shareholders report profits and losses on their personal tax returns, allowing them to use business losses to offset other income.
Tax-beneficial income rules
Shareholders of an S corporation can be employees of the business, allowing them to draw a salary in addition to receiving dividends and other tax-advantaged distributions. Self-employment tax liability is reduced while the corporation itself benefits from deductions for salaries and other business expenses.
Personal asset protection
S-corporations protect the personal assets of the shareholders, as they are not personally responsible for business liabilities and debts. This means that creditors should not be able to seize shareholder homes, bank accounts, and other personal assets to settle business obligations.
Easy transfer of ownership
With S-corporations, there are no negative tax consequences or intricate accounting rules associated with transfer of ownership. With a partnership or LLC, the entity usually dissolves when an interest amounting to more than 50 percent is transferred.
There are some limitations: S-corporations can only have a maximum of 75 shareholders, and unlike with LLCs, only U.S. citizens can be shareholders. But the advantages of the S-corporation structure are significant for many business owners. If you’d like to learn more, please get in touch with us today!
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