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An S corporation, also known as an S subchapter, refers to a type of corporation.Requirements give a corporation with 100 shareholders or fewer the benefit of incorporation while being taxed as a partnership.
Corporate taxes filed under Subchapter S may pass business income, losses, deductions, and credits to shareholders.
Shareholders report income and losses on individual tax returns, and pay taxes at ordinary tax rates. S corporation shareholders must be individuals, specific trusts and estates, or certain tax-exempt organizations.
Here are some of the most frequently cited advantages that an S corp can offer its owners. You should be clear on your immediate and long-term goals.
For example, pass-through taxation generally is positive because it results in less taxation. But if a business goal is to accumulate money for expansion—perhaps to build a new facility—a C corporation could be the better choice because income can be retained within the corporation.
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Asset Protection
One major advantage of an S corporation is that it provides owners limited liability protection, regardless of its tax status. Limited liability protection means that the owners’ assets are shielded from the claims of business creditors—whether the claims arise from contracts or litigation. All corporations, as well as LLC, provide limited liability protection.
Pass-Through Taxation
The tax benefit for S corporations is that business income, as well as many tax deductions, credits, and losses, are passed through to the owners, rather than being taxed at the corporate level. This avoids the chance of “double taxation,” that occurs with C corporations when dividend income is taxed first at the corporate level and then at the shareholder level. This is because an S corp is a pass-through entity for federal (and most state) income tax purposes. An LLC is also a pass-through tax entity. Note that it can elect to be taxed as a C corporation if business owners determine that is in the company’s best interests.
Salary and Dividend Payments
An S corporation owner can opt to receive both a salary and dividend payments from the corporation. This can result in a lower tax bill overall.
Why? This is because dividends are not subject to self-employment tax. Further, the S corporation can deduct the cost of the wages paid when computing the amount of income that is passed through to the shareholders.
However, the division between salary and dividends must be “reasonable” as determined by the IRS. (The IRS watches these types of transactions very closely and will step in and re-characterize the income if it feels the payments were unreasonable).
Ease of conversion
If S corporation shareholders want to be taxed as a C corporation, all that’s required is filling this election with the IRS.
An LLC that is taxed as a pass-through but wants to be taxed as a C corporation can also simply make a filing with the IRS. However, if the LLC owners want to convert their LLC into a C or S corporation, they will have to comply with both their state corporation and LLC laws and file documents with the state. These filings include dissolution/withdrawal filings, formation filings, and more.
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