S Corporation (also known as S Corp) is a tax status that can be useful to small enterprises whose owners wish to avoid paying both personal income tax and corporate income tax on the business’ income. An S Corp’s profits or losses are not subject to federal corporate income tax. Instead, they pass through and are distributed among the S Corp’s shareholders, who then report it on their personal income tax returns. In other words, they are treated like partnerships by the IRS, and not like traditional C Corporations. This makes S Corp status an attractive choice for owners who work for their business.
If you wish to file as an S Corp, first consult IRS Form 2553 to see if your company qualifies. In addition, be aware that all shareholders who work for the company must be paid fair market value for their services, or else the IRS might choose to treat some of their distributions from the company’s earnings as wages and tax them accordingly. Then, all of the company’s shareholders must sign and file Form 2553 with the IRS to signify that their approval. Limited liability companies (LLCs) may request S Corp status using Form 2553 so that they are treated as such for tax purposes.
S Corp status provides clear benefits to the owners of a company when it comes to how they are taxed. Unlike LLCs, S-Corps pay FICA tax based only on the salary paid to the shareholders who actually work for the company. Distributions from the business are treated as the shareholders’ personal income, and so are not subject to FICA tax. S Corp status also places some limits on the shareholders’ personal exposure to the company’s financial liabilities, and reduced the impact on the company if one of the shareholders leaves for any reason or sells his shares.
If you are considering S Corp status, you should also be aware that not all states treat them the same way. Most states treat them just as the IRS does, but some do not recognize S Corp status at all and treat them just like C Corps. Make sure you understand how the state in which you are incorporated treats S Corps before you decide whether or not it will work for you. Also, you should be aware that if your company ceases to meet the qualifications for S Corp status, the IRS will treat it as a C Corp. Therefore, you always need to be mindful of meeting those qualifications, and of the consequences for your business and yourself if your company is taxed as a C Corp instead of an S Corp.
