Question

An S corporation is considered a flow-through business entity that has the advantages of both the corporation and proprietorship. Discuss the general rules that govern S corporations. What are some of the operational rules that effect various code provisions on S corporations? Go to www.irs.gov and provide a synopsis of the similarities and differences between S corporations and one other form of business

Answer 1

General rules in S-corp -

If you will be raising capital by selling equity. Most investors don’t like K-1s. Most investors like preferred shares (S Corporation cannot have multiple classes of stock). Most investors like Qualified Small Business Stock (S Corp stock does not qualify).

If you will have shareholders that are not individuals, are non-resident aliens, or will have more than 100.

If you are unable to pay all active owners a defensible salary. (Although I believe you are only required to have a defensible salary if the corporation is profitable, check with a CPA).

purpose and advantages of S-corp

Limited liability for management and shareholders.

• Unlimited number of management, no state residency requirements.

• Distinct, court-recognized existence, which helps protect you from personal liability than can cause you to loose your personal wealth in assets like your home, car, or nest egg.

• Flow-through taxation: Profits are distributed to the shareholders, who are taxed on profits at their personal level.

• Good privacy protection, especially in Nevada and Wyoming.

• Great income-splitting potential for owner/employees. Can take smaller salary and pay income taxes and regular payroll deductions, then take remainder of profit as a distribution subject to income tax only.

• S Corporations are great for businesses that:

• will provide a service (i.e. consultants);

• will not have significant start-up costs;

• will not need to make major equipment purchases before beginning operations; and

• will make a sizable amount of money without a great deal of effort and expense.

Difference Between S-Corp and C-Corp -

S-Corp and C-Corp are IRS tax designations for companies. S-corporations are treated as “pass through” entities. This means they don’t pay taxes themselves, rather the owners just get the company’s income/expenses added to their own personal tax returns (and then they have to pay “extra’ taxes known as self employment taxes).

C-Corporations pay their own taxes.

If you were listening to the tax plan debate, this became a big issue. Most small businesses are taxed as pass through entities. This means if the corporate tax rates were cut, it would not help small businesses at all. Luckily (for me) they did come up with a work around where pass through entities will now also realize a tax reduction in how the IRS counts pass through income.