Most corporations elect to be classified as S Corporations due to the tax advantages they can receive. An S Corporation is one that elects to pass income, loss, credit and deductions by way of their shareholders for purposes of federal tax. This allows income and losses to be calculated through the personal tax rates of each individual shareholder.
For a company to get S Corporation status it must satisfy the following conditions:
It should be incorporated in the United States.
It must be owned exclusively by allowable shareholders. This includes individuals, trusts and estates that do not include partnerships, other corporations or shareholders outside the United States.
It should have less than 100 shareholders.
It should only have a single class of stock.
It should be an eligible corporation, since some corporations such as financial institutions, insurance companies and sales corporations whether domestic or international are not eligible.
A corporation is classified as such when the Form 2553 election by a Small Business corporation form is signed by all shareholders and submitted to the IRS.
S Corporation benefits are mainly tax rewards and can be categorized as follows:
Avoiding double taxation – An S Corporation is also known as a pass through corporation. This means that all income, losses, deductions and credits are passed through the individual shareholder dividends. The tax imposed on these individual shareholders depends on the percentage ownership that the shareholders own in the corporation. This advantage derived is that the income, losses, credits and deductions are not taxed at the corporation level but only at the shareholder level. Normally there would be a tax imposed at the corporation level and at the shareholder level hence the double taxation.
Considerable savings on taxes – Another S Corporation advantage is the ability of the shareholders to make huge tax savings on their income. Apart from the fact that they avoid taxation of income at the corporation level, shareholders can make even greater tax savings by spreading the income earned to other members of the family. Children over the age of 13 who have not reached the legal adult age belong to a lower tax bracket. A shareholder can pass on this income to such children and save more from taxation.
Using corporate net losses to lower taxation of income from other sources – The ability to use these losses to offset taxes against personal income from other sources is another advantage of having an S Corporation. The S Corporation returns in this case capitalize on the time value of money. The only hitch here is that the shareholder must have substantial ownership in the S Corporation to be able to make such an offset.
There are many factors to be considered before you decide to turn your corporation from a C Corporation to an S Corporation. S Corporation benefits should be weighed carefully and researched beyond the scope of the advantages listed above. You should consult with a public accountant for more advice on this issue.
About the Author: Haliyma Barrow is a business blogger based in New York. Haliyma regularly contributes articles about various legal issues, such as child custody guideline for parents.