A popular type of corporation is the S-Corporation business entity type. Legally, there is no difference between a C-Corporation and an S-Corporation. However, for tax purposes, the two are very different. An S-Corporation business entity is just a corporation that has made an “S-election” for tax purposes.
S-Corporations can be a popular entity choice for new businesses. Also, since it is relatively easy to make the “S-election” many C-Corporations that decide their current business entity type is not working can make this election, whereas converting to another type of business (such as an LLC or LP) may be impractical.
Advantages of the S-Corporation Business Entity Type
1. S-Corporation does not pay Federal tax, instead, its shareholders pay the tax on income directly
2. Therefore, double taxation that occurs on C-Corporation dividends is eliminated
3. C-Corporations can be easily converted to S-Corporations
4. Shareholders enjoy the same liability protections as under a C-Corporation
(Similar to: What is an LLC Company Type?)
Disadvantages of S-Corporations
1. Entity must be relatively small and simple, for example:
a. Number of shareholders limited to 100 or less
b. Shareholders must all be individuals (no corporate or partnership shareholders)
c. Only one class of stock, so all shareholders must have the same voting rights, and certain shareholders cannot receive preferential returns over other shareholders
2. Annual franchise tax applies in many states (the amount varies, in California, it’s 1.5% of net income with a minimum of $800)
(Similar to: Is the C-Corporation Business Entity Type Right For You?)
Although making an S-election is relatively simple, there may be unforeseen tax consequences to doing so. Be sure to check with a trusted advisor to make sure it’s the right choice for your business. Contact me if you’re choosing an entity type. I can help you decide if an S-Corp is right.
Do you have an S-Corp? Was it the right choice? Do you think it could be a good fit for your business?
By David Olson, CPA, Accountant at WHH
David specializes in entity structures, entity reorganizations, and IC-Disc. His experience working with businesses that have multiple entities and complex ownership structures gives him expertise in understanding the taxation and planning that must be considered.
