Lets talk about S Corporations

What is a S Corporation?

S Corporations are corporations that elect to pass corporate income, losses, deductions and credits through to their shareholders for federal tax purposes. Shareholders will report this income or loss on their personal income tax return and then are taxed at the individual level.

S Corporations are popular because they offer limited liability for owners and shareholders. And because of the flow through of income and expenses on their personal tax return, it allows them to avoid double taxation on corporate income.

What are the requirements? 

To qualify for S Corporation status, you must meet the following:

  • Be a Domestic Corporation

  • Shareholders may only be individuals, certain trusts, estates and certain exempt organizations. They may not be partnerships or corporations.

  • May have no more than 100 shareholders.

  • Have only one class of stock

  • Not be an ineligible corporation (ex. certain financial institutions, insurance companies and domestic international sales corporations).

In order to become an S Corporation, the corporation must submit Form 2553, Election by a Small Business Corporation signed by all shareholders.

What is considered reasonable compensation? 

There are other requirements that come along with becoming a S Corporation. An S Corporation must pay a reasonable salary to the working owner of a business.

For example, if you are a Single Member S Corporation, you must pay yourself a salary and it must be reasonable. This is a hot topic amongst S Corporations and one of the top reasons S Corporations tax returns are audited.

The IRS has no specific guideline for reasonable compensation but there are factors that are considered in determining reasonable compensation:

  • Training and experience

  • Duties and responsibilities

  • Time and effort devoted to the business

  • Dividend history

  • Payment to non-shareholder employees

  • Timing and manner of paying bonuses to key people

  • What comparable businesses pay for similar services

  • Compensation agreements

  • The use of a formula to determine compensation

How to file a S Corporation

To incorporate, once you have established your State, follow these steps:

  • Make sure your Business name is available.

  • If your Business name will be anything than your actual name, file a “Doing Business As” with your State.

  • Prepare your Articles of Incorporation with the Secretary of State.

  • Keep corporate minutes of all board and shareholder meetings.

  • Apply for an EIN number by preparing and submitting an IRS Form SS-4.

  • Check and verify what type of state and local permits are required in your industry.

It is best to consult with an Accountant or Lawyer to determine what the best structure will be for your business. You can always start as an LLC and later switch to an S Corporation as your business grows.

Reference: https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations

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