If you are starting a business but aren’t sure what sort of entity to create, you may wish to consider becoming an S corporation. These companies enjoy certain distinct tax advantages, while retaining much of the same structure and operation as a “regular” C corporation. A College Station S Corporation attorney can help you decide which form of corporation is better suited to your needs, but the following provides a brief overview.
Forming an S Corporation
You may be under the impression that you need to choose whether to become an S or C corporation from the outset, but such is not the case. In fact, your corporation will have to begin as a C entity, after which you can file the appropriate paperwork with the IRS, form 2553, to change to S status. Once you become an S corporation you may switch back at any time. However, you would then have to wait five years before again switching to S status.
How Do the Two Entities Differ?
C and S corporations are kindred business types: each issues shares of stock, and must hold a minimum of one annual meeting. The minutes of each meeting must be recorded and kept. One of the major differences, however, is that while C corporations can issue different types of stock, an S variety can only issue one type. Thus, all shareholders own the same kind of stock. It is simply a matter of how much stock they own. Other distinctions include:
- An S corporation can have no more than 100 shareholders.
- It cannot derive more than 25% of its income from passive income.
- At least 5% of its income must come from domestic goods.
- Shareholders who are also employees must pay taxes on their benefits.
- Banks and insurance companies cannot form as S corporations.
A common understanding is that S corporations are preferable because of certain tax advantages they bring. A College Station S Corporation attorney can help you decide whether these advantages offset other issues in your case. For instance, a C corporation is generally capable of accumulating capital more easily than its S counterpart because tax rates for C corporations are lower.
That said, one of the main features that make S corporations popular is the avoidance of so-called “double taxation.” A C corporation pays corporate taxes; the shareholders then pay taxes on any dividends they receive. An S corporation does not pay corporate taxes, although an informational tax return must be completed. Instead, the tax flows through the entity and is paid directly by the shareholders in direct proportion to the percentage of the stocks each owns.