While the shining C Corp gains a lot of attention— be it scam (think Coca Cola email hoax) or success—many don’t know its brother, S Corporation (or S Corp). Yet, just as several Fortune 500 companies benefit from unlimited board members and front-end tax savings with C Corporation business entities, small business owners could leverage the S Corp’s pass-through taxes and avoid double taxation. Just what makes an S Corp an S Corp? And how does it differ from other business entities? Knowing these 5 things about an S Corp just may change the way you do business. (As well as the way you conduct a South Dakota Secretary of State business search—or other business name search for that matter.)
1. 100 Shareholders Tops
According to the IRS, businesses with an S Corporation status can’t have more than 100 shareholders—which, as we mentioned, is unlike the C Corp. In return for capping its stockholders, businesses can enjoy being taxed as a partnership while still holding a corporation status. Meaning, S Corps won’t be double taxed yet members aren’t personally liable.
Besides only having 100 shareholders (at most), other qualifications include that the business must be domestic, there’s only one level of stock, and it needs to fit the eligibility requirements of a standard corporation. So, some financial systems, insurance companies etc. may not qualify.
2. All Corporations are C Unless They File for an S Status
You have to do one extra step. Surprisingly, the articles of incorporation that you file with the Secretary of State doesn’t have a designated C or S status that you check off. Instead, if you want an S status, you must file for it. If you don’t, your company will be viewed and treated as a C Corporation—because it is. (Remember, S Corps are taxed as partnerships, which is different from the standard corporation filing status of a C Corp. Perhaps this is why you need to file for that status?)
3. S Corps Were Designed with a Specific Intention in Mind
S Corps were created to bridge the gap between corporation and partnership. Partnerships on one hand must have one member be fully liable; corporations, on the other, don’t. Unlike corporations that pay taxes corporately and personally, partnerships don’t pay income tax since they’re not treated as an employee. (The partners do pay income tax though.)
S Corps merge these traits. The S Corp behaves like a partnership, with the owner paying his/herself a salary plus dividends split from the leftover profits. Meanwhile, the S Corp and C Corp share a similar business structure, composed of shareholders, directors, and officers. This makes it a great potential option for small to mid-sized businesses, who can enjoy the limited liability while having a minimal number of shareholders.
4. Don’t Sweat the Self-Employment Tax
Normally, if you have a sole proprietorship or limited liability company (LLC), all of the business revenue is taxed. However, an S Corp can potentially reduce the amount of self-employment tax you owe.
Taxable income is divided between salary and distribution. The distribution refers to the dividends, additional business income that’s equally split up among shareholders. This income, which normally is 40% (or less) of your revenue, isn’t taxed. Salary, as its name suggests, is just that—a fixed (annual) payment you receive. Usually this is around 60% (or more) of the company’s revenue. And, yes, you must pay self-employment tax on this.
Why the S Corp is So Attractive
This is what makes an S Corp attractive since, for example, sole proprietorships have to pay approximately 15% in self-employment tax both as the employee and business owner. Which comes out to roughly a little under one-third (28-30%). Like we said, with an S Corp, you’d only have to pay 60% in self-employment tax.
Why the Specific Percentages?
Let’s say you assign 70% of the business revenue as distribution and 30% salary. That’s 70% of the business income not subjected to self-employment tax. Already, it looks like you’re trying to avoid paying taxes…which appears suspicious. So, steer clear of large percentages on distributions—to bypass a possible audit. Besides, because this is a possibility, the IRS monitors low-salary, high-distribution ratios. If they notice this ratio, the IRS could transfer a larger amount in your salary, increasing the taxes you owe. (Plus, you wouldn’t have the limited liability coverage, putting your personal assets at stake should there be a discrepancy with a client.)
5. Not Forming Any Entity (Including an S Corp) Could Cost You
You decide not to form any entity for your business—what now? Doing that unfortunately makes any business income and expenses personal. As in it’ll be under Schedule C, your personal tax return. Before you shrug, know that Schedule C is the tax return most likely to be audited, according to Forbes.
6. Bonus: The S Corp Double Tax Loop Hole
Depending on the state your business is registered in, you may have to pay additional taxes other than self-employment. For example, New York City and California treat S corps similar to C corps; New York City actually imposes an income tax (6.5-9%%) on business done within the City.
Although called a different name, California levies a franchise tax of $800 (at the minimum) on the business net income. Remember, forming an S Corp means that your business becomes its own entity—like your standard C Corporation; because of the similar structure and overlapping features—like limited liability and independent life—it’s important that you browse Secretary of State websites, such as the South Dakota secretary of state page, to see if you may be subjected to other taxes such as these.)
Conducting a South Dakota Secretary of State Search?
Or perhaps another state’s? Use Sec State to easily navigate to each state’s business website. In a few clicks, you can conduct a business name search, check for name availability, and see what each state’s laws are regarding each business entity. For more information about S Corps ad business name searches, contact Sec State.