Setting up an S Corporation

Introduction

There are two types of corporations:

• S corporations, and
• C corporations

We will take a close look at the drawbacks and S corporation advantages, also known as S corps.

S corps offer limited liability and simple tax treatment. They’re pass-through entities which means the profits of the business pass through to the owners personal tax returns.

Before the advent of LLCs, using an S corp was the main way a business owner could limit his liability and also enjoy similar pass-through tax treatment to partnerships and sole proprietorships.

Many tax pros and attorneys argue that LLCs have largely replaced S corps because they offer they same liability protection and tax treatment but are easier to run.

Setting Up Your S Corporation

Like LLCs, when you set up any corporation you have to pay state filing fees. These vary from state to state but are typically between $100 and $300. In some states it’s cheaper to set up an LLC and in others it’s cheaper to set up a corporation. However, the cost difference is rarely big enough to influence your choice of business structure.

For example in California the state filing fee for an LLC is $70, for a corporation it’s $115. In Texas the filing fee for an LLC is $325 and $332 for a corporation.

There are plenty of online firms like mycorporation.com which will set up your corporation for just a few hundred dollars.

So what’s the difference between setting up an S corporation and a C corporation? An S corp is just a corporation that has filled in IRS Form 2553 electing for pass-through S Corp Tax treatment. Hence the legal and other costs of setting up an S corporation are similar to those of a C corporation. Online incorporation services usually charge less than $100 to complete Form 2553 for you.

Once the S corp election is made it continues until you stop it. You do this by sending a letter to the IRS. However, you have to be careful because, once revoked, S corporation status cannot be claimed again for another 5 years.

Tax Treatment of S Corporations - S Corp Tax

S corporations are ‘pass-through’ entities because the profits pass through the business and onto the owner’s personal tax return. The business is not taxed separately.

This means they’re taxed in pretty much the same way as sole proprietorships and partnerships.

In fact the only business that is taxed separately is the C corporation. As we’ll see shortly, C corp profits are taxed at corporate income tax rates.

Remember LLCs don’t have their own set of tax rules. You can decide for yourself if you want your LLC be taxed like a sole proprietor/partnership, S corporation (S Corp Tax) or C corporation.

So this section on the tax treatment of S corporations is important for LLC owners as well because many do, in fact, think about electing S corp tax treatment.

Even though S corps are pass-through entities they do have to file a special tax return – Form 1120S – reporting the profits or loss of the business. K-1 forms are then given to the shareholders who report their share of the income on their individual tax returns.

Many businesses start life as an S corp because any losses can flow through to your individual tax return and can offset other income. When they become more profitable they sometimes convert to C corporations to benefit from income splitting and fringe benefits.

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