Why S Corporate Status Makes Sense for A Number of Small Businesses
Most business owners choose to initially choose to form as a sole proprietorship because it costs less and there is less bureaucracy. However, many also switch to either a C corporation or a limited liability company (LLC) at some point in order to benefit from additional protections.
While we have previously discussed the advantages of having an S corporation, we have not specifically discussed why small businesses may want to initially form as an S corporation, which provides a number of unique benefits, especially to startup companies. Below we discuss the characteristics and benefits of each classification:
C corporations provide the most protection from liability for both shareholders and business owners because they allow the businesses to exist as separate entities. Because the C corporation is a legally separate entity, any legal repercussions have no bearing on the individual owner(s)’ personal assets. It also offers a significant amount of flexibility when it comes to buying and selling stock shares, offering employees stock options, and allowing for an unlimited number of shareholders; amongst other benefits. While dividends are taxable as income, business expenses, employee benefits, and retirement plan expenses are tax deductible to the company. C corporations can be costly due to a number of filing fees that must be paid, and the steps to form a C corporation can also be elaborate. Specifically, the following is required:
- Corporate bylaws;
- Articles of Incorporation (filed with the state);
- Employee Identification Numbers or Tax ID Numbers; and
- A Board of Directors, which the owners regularly meet with and where minutes are kept of meetings.
Limited Liability Companies
The limited liability company (LLC) is another popular business structure. An LLC also provides the owner(s) with protection from liability and is responsible for its own finances. It also involves very little paperwork to set up, a Board of Directors is not required, the owners make the decisions (after filing the Articles of Organization with the state), and an Employee Identification Number is still required.
Perhaps most importantly, when it comes to an LLC, there are choices as to how the owners want to be taxed. The LLC is what is known as a pass-through entity, which is similar to a sole proprietorship or partnership. Members can decide to have the company taxed as a C corporation or they can have profits and losses passed through to them and claimed on their personal tax returns.
Another option is the S corporation. S corporations retain the same liability protection of the C corporation and LLC, however, they are not taxed at the corporate level because they are subject to pass-through taxation. S corporations also provide income-splitting benefits for the owner(s): Owner(s) can take a reduced salary and taking the remainder in the form of dividends, which are not subject to self-employment tax, only income tax. That being said, S Corporation status is not necessarily beneficial to companies with high earnings, and there are limits as to the number of shareholders they can have. However, when it comes to small businesses and startups, losses can be written off on clients’ personal tax returns, which can provide significant benefits.
In order to qualify for S corporate status,
- The business has to be an LLC or United States corporation;
- Every shareholder must consent to it being an S corporation;
- Every shareholder must be a citizen or permanent resident alien;
- The company is limited to 100 shareholders or less;
- The company can only have one class of stock; and
- Shareholders must be certain qualified trusts, estates, or individuals.
Contact Our Florida Business & Corporate Law Attorneys to Find Out More
In general, it is usually recommended that businesses start as LLC is because the structure is so simple and flexible. As the company grows, shifting to S corporation status usually makes more sense. It is typically easiest to simply elect to file your LLC is an S corporation, while noting that you can always refer back to an LLC.
For more information on business and corporate law—including business formation—contact our experienced Tampa business & corporate attorneys at HD Law Partners today.