An S corp is a corporation with the
Subchapter S designation from the IRS.
To be considered an S corp, you must first
charter a business as a corporation in the
state where it is headquartered. According
to the IRS, S corporations are“considered
by law to be a unique entity, separate and
apart from those who own it.”This limits
the financial liability for which you (the
owner, or“shareholder”) are responsible.
Nevertheless, liability protection is limited
— S corps do not necessarily shield you
from all litigation such as an employee’s
tort actions as a result of a workplace
incident.
What makes the S corp different from
a traditional corporation (C corp) is that
profits and losses can pass through to
your personal tax return. Consequently,
the business is not taxed itself. Only the
shareholders are taxed. There is an important caveat, however: Any shareholder
who works for the company must pay him
or herself “reasonable compensation.”
Basically, the shareholder must be paid fair
market value, or the IRS might reclassify any additional corporate earnings as
“wages.”
Combining the Benefits of
an LLC with an S Corp
There is always the possibility of
requesting S corp status for your LLC. Your
attorney can advise you on the pros and
cons. You’ll have to make a special election
with the IRS to have the LLC taxed as an
S corp using Form 2553. And you must file
it before the first two months and 15 days
of the beginning of the tax year in which
the election is to take effect.
The LLC remains a limited liability
company from a legal standpoint, but for
tax purposes it’s treated as an S corp. Be
sure to contact your state’s income tax
agency where you will file the election
form to learn about tax requirements.
on profits above a specified limit. Other
states don’t recognize the S corp election
and treat the business as a C corp with
all of the tax ramifications. Some states
(like New York and New Jersey) tax both
the S corps’ profits and the shareholder’s
proportional shares of the profits.
Your corporation must file the Form
2553 to elect “S”status within two months
and 15 days after the beginning of the tax
year or any time before the tax year for the
status to be in effect.
Advantages of an S
Corporation
• Tax Savings. One of the best features
of the S corp is the tax savings for you
and your business. While members of an
LLC are subject to employment tax on the
entire net income of the business, only the
wages of the S corp shareholder who is
an employee are subject to employment
tax. The remaining income is paid to the
owner as a“distribution,” which is taxed at
a lower rate, if at all.
• Business Expense Tax Credits.
Some expenses that shareholder/
employees incur can be written off as
business expenses. Nevertheless, if such
an employee owns 2 percent or more
shares, then benefits like health and life
insurance are deemed taxable income.
• Independent Life. An S corp
designation also allows a busi