ColorBlind Images/Blend Images/Getty Images
An S Corporation is one of several optimal structures for a small business. It blends some of the benefits of a sole proprietorship with those of a C Corporation. An S Corporation is often considered alongside a limited liability company when someone is looking for something more formal than a sole proprietorship.
Like an LLC, an S Corporation has pass-through taxation, which means you only pay taxes once. The profits of the business are distributed to owners, who then pay taxes on their share of the earnings. In contrast, a C Corporation experiences double-taxation. The business pays taxes on corporate earnings and each shareholder pays taxes on his share of the distributed earnings. By working for the business and receiving a salary, an S Corporation owner also may avoid hefty self-employment penalties common with a sole proprietorship.
Simplicity and Asset Protection
An S Corporation is easy to set up relative to other formal business structures. Some people operate as sole proprietors just to avoid formalizing their operation. However, an S Corporation allows for greater credibility with customers, partners and suppliers. Similar to a C Corporation or LLC, an S Corporation also insulates the personal assets of owners, because the business is treated as a separate legal entity from its owners. If the company is sued, for instance, the business assets are at risk, but not the financial assets of owners.
An S Corporation does have a few more setup and ownership restrictions than an LLC. First, you must be a U.S. citizen or legal resident to form an S Corporation. Also, whereas C Corporations and LLC allow unlimited ownership, an S Corporation is limited to 100 shareholders. Profit distribution or dividends must align with a shareholder's level of ownership. If someone owns 5 percent of the business, he must receive 5 percent of income distributions. LLCs have more distribution flexibility.
There are more costs to setting up an S Corporation than there are with an LLC. As with C Corporations, you file formal legal documents and pay related fees to set up an S Corporation. Annual report filing fees and franchise fees are additional costs that you may pay with an S Corporation that you don't incur with a partnership or sole proprietorship.
- Inc.: Should Your Business Be an LLC or an S Corp?
- BizFilings: S Corporation Advantages and Disadvantages
- Internal Revenue Service. "S Corporations." Accessed May 13, 2020.
- Internal Revenue Service.gov. "Form 2553." Accessed May 13, 2020.
- Internal Revenue Service.gov. "Forming a Corporation." Accessed May 13, 2020.
- Internal Revenue Service.gov. "Form 1040." Accessed May 13, 2020.
- CA.gov. "Corporations." Accessed May 13, 2020.
- Internal Revenue Service.gov. "Form 1120-S." Accessed May 13, 2020.
- Internal Revenue Service.gov. "Schedule K-1." Accessed May 13, 2020.
- Internal Revenue Service.gov. "Closing a Business Checklist." Accessed May 13, 2020.
- New York State.gov. "Forming a Business Corporation in New York." Accessed May 13, 2020.
- Internal Revenue Service.gov. "S Corporation Employees, Shareholders and Corporate Officers." Accessed May 13, 2020.
- Massachusetts Budget and Policy Center.org. "How S-Corp and Other 'Pass-Through' Income is Taxed and the Effects of Proposed Tax Reforms." Accessed May 13, 2020.
- Internal Revenue Service.gov. "Some S corporations may want to convert to C corporations." Accessed May 13, 2020.
- Internal Revenue Service.gov. "Rev. Proc. 2013–15," Page 3. Accessed May 13, 2020.
- S-Corporation Association of America. "The History and Challenges of America's Dominant Business Structure." Accessed May 13, 2020.
Neil Kokemuller has been an active business, finance and education writer and content media website developer since 2007. He has been a college marketing professor since 2004. Kokemuller has additional professional experience in marketing, retail and small business. He holds a Master of Business Administration from Iowa State University.