If you’re a small business owner, you’ve likely come across the term “S corporation” in discussions about business structures and taxation. But what exactly is an S corporation, and why might it be a beneficial choice for your business?
In this blog, we’ll explore the concept of an S corporation, key characteristics, and the advantages it can offer to businesses of various sizes and industries.
What Is an S Corporation?
An S corporation, or S corp, is a type of business structure that combines elements of both a corporation and a partnership. It allows business income and losses to pass through to the individual tax returns of the company’s shareholders, avoiding double taxation at the corporate and individual levels. S corporations are typically chosen by small to medium-sized businesses for their tax benefits and operational flexibility.
An S corporation essentially eliminates the step of classifying a business as a separate entity for tax purposes by passing its income and expenses directly to the business owner and shareholders. These shareholders are responsible for including business finances in their personal taxes.
While owners of larger companies generally benefit from the protection of keeping potential business losses separate from personal funds, owners of small businesses often find it more convenient to keep everything together instead of paying separate corporate taxes.
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IRS Requirements for S Corporations
Like Limited Liability Companies (LLCs), S corporations are intended to better support the unique needs of small businesses. The IRS imposes certain requirements on how S corp businesses can function. S corporations need to adhere to size, location, and complexity guidelines to operate legally under this status. This business’s articles of incorporation, articles of organization, or bylaws often outline these requirements to ensure directors and other leaders align on the same page.
Size
Businesses that are classified as S corporations need to be relatively small for their tax differences to make sense. An S corporation can consist of no more than 100 shareholders, while most other types of businesses have higher limits or allow an unlimited number of shareholders.
Location
A business must be incorporated within the United States to qualify as an S corporation. Although an S corporation may conduct certain types of business with international companies, its shareholders must be U.S. citizens.
Complexity
S corporations were designed to incorporate tax differences that make sense for smaller businesses, which means they cannot be too large or complex. Businesses that are interested in expanding their services will generally need to change their status to a C corporation or another structure.
How to Set Up an S Corporation
Your small business must gain approval as an S corporation by the IRS before you can take advantage of its benefits. The most important steps for starting an S corporation include:
- Choosing a name for your business
- Filing articles of incorporation to provide evidence that an S corporation is an appropriate structure for your business
- Issuing stock
- Electing a board of directors and selecting other leaders of your business
- Verifying the current structure of your business meets other local and national S corporation requirements
- Obtaining an Employer Identification Number (EIN) to file taxes
- Applying for S corporation business licenses at the state and local levels
- Creating bylaws that specifically address your business’s new status as an S corporation
- Scheduling and holding annual meetings, at which time you will re-evaluate whether your business meets current S corporation requirements
Advantages and Disadvantages of S Corporations
Classifying your business as an S corporation may be an excellent fit for you, but it may not work well for every small business owner. Here are some of the most important things to consider before obtaining S corporation status for your small business.
Benefits of S Corporations
Some of the main benefits of classifying your small business as an S corporation include:
- Pass-through taxation
- Protection for certain assets
- Stronger credibility for newer small businesses
- Straightforward process to transfer ownership of business
- Option to use cash accounting instead of accrual methods
Drawbacks of S Corporations
Some reasons an S corporation may not be a good fit for your business include:
- Higher ongoing expenses
- You need to use calendar year instead of fiscal year for tax purposes
- Limitations on stock ownership
- Limitations on shareholders
- More financial risk to business owners versus keeping business completely separate
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Keeping track of the unique IRS requirements of S corporations can be tricky, especially if you’re used to the more traditional business structure of a C corporation.
Quality board management software provides an effective tool for staying on top of current requirements and ensures you have the information you need, especially if members of your board of directors are responsible for making sure your business aligns with IRS guidelines, as well as taxes and financials.
Providing a better way to manage your organization’s files is just one of many ways OnBoard makes life easier for your board of directors. Other frequently used features include:
- Options for securely creating, distributing, and storing agendas and minutes for each board meeting
- A secure messaging system less susceptible to hacking than email or social media
- Simple integration with Zoom and other video conferencing platforms
- Options for keeping track of voting results
- A wide range of meeting analytics to track the success of board meetings over time
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About The Author
- Josh Palmer serves as OnBoard's Head of Content. An experienced content creator, his previous roles have spanned numerous industries including B2C and B2B home improvement, healthcare, and software-as-a-service (SaaS). An Indianapolis native and graduate of Indiana University, Palmer currently resides in Fishers, Ind.
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