Benefits of S Corps: If you’re about to start a small business, one of the first things you should do is incorporate, which is the act of registering your business as a corporate entity that’s separate from the owner, shareholders, and employees. Incorporating provides numerous advantages, such as tax savings and protection from liability. There are different types of corporations with different requirements, and the right one for you will depend on the structure of your business.
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An S corporation, or S Corp, is a type of corporation that’s particularly suitable for small businesses. To register as an S Corp, the business must be based in the U.S., have one class of stock, and have less than one hundred shareholders. There may be additional requirements based on the state where your business is located.
An S corp provides its shareholders with some protection against liability by keeping shareholders’ assets separate from the company’s assets. This protects shareholders from becoming legally responsible if the company gets sued. It also protects shareholder assets from being seized by creditors if the company owes any debts.
The tax benefits are perhaps the biggest advantage of filing an S corp. Under this designation, a shareholder receives a salary with income taxes deducted, and any remaining profits from the business are distributed among the shareholders as dividends. This is commonly referred to as “pass-through taxation” because income passes directly to the shareholder and is taxed once at the personal level rather than twice at the corporate and personal levels. In many cases, this saves the business owner money they might otherwise have to spend on corporate and self-employment taxes.
Due to the structure of an S corp, it’s much easier to transfer ownership compared to if the business were a simple LLC or sole proprietorship, which may trigger tax consequences. This is also useful in case the owner passes away unexpectedly and another shareholder must step up to take control of the business. The exact process may vary between states, so it’s helpful to consult a tax advisor if there is an upcoming transfer of ownership. Typically, an ownership transfer can be a simple, straightforward process as long as the S corp fulfills all other legal requirements, such as staying up-to-date on paperwork and taxes.
Generally speaking, corporations must use the accrual method of accounting, which tracks revenue based on when expenses and income are accrued. On the other hand, S corps can choose to operate using the cash method of accounting, which records expenses and income after the monetary transaction takes place. The cash method is usually simpler and easier to manage, and taxes are paid from already received income.
Turning your small business into an S corp provides extra credibility, making it easier to run your business. An S corp also allows you to collect an official paycheck, which can be helpful if you ever need to take out a loan, such as for the purchase of a home. A paystub paid to you by your business is a much more reliable proof of income than last year’s tax return or a list of your bank transactions.
To register your business as an S corp, you must file Articles of Organization with your state’s business authority. Usually, this will be your local Secretary of State. Then, you must submit Form 2553 to the IRS to fulfill the federal requirements of incorporating your business. You must also appoint a board of directors and hold an organizational meeting to complete organizational tasks such as distributing stock certificates or adopting company bylaws.
To reduce your tax bill, protect your shareholders’ interests, and legitimize your small business, you may benefit from turning your business into an S corp. The specific requirements will vary state by state, and some businesses may be easier to incorporate than others. While a tax professional isn’t necessary for setting up an S corp, you may find it helpful to recruit one specializing in the laws of your state.
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