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What Is an S Corporation?

Curiale Hostnik PLLC Dec. 13, 2023

Understanding the different types of business entities can be a daunting task, especially when you're trying to understand the intricacies and implications of each. One such entity that often piques the interest of business owners is the S Corporation. As an entity that cleverly combines the limited liability protection of a corporation with the tax advantages of a partnership or sole proprietorship, it's no wonder why.

At Curiale Hostnik PLLC, we've made it our mission to guide businesses through these complexities. Whether you're considering forming an S Corporation, need advice on existing business structures, or are grappling with other legal matters related to business law, we're here for you. With our guidance, you'll get to understand how an S Corporation operates, its advantages and disadvantages, and most importantly, whether it’s the right fit for your business. 

What Is an S Corporation? 

An S Corporation, also known as an S Corp, is a unique type of business entity. It combines the limited liability protection of a corporation with the tax advantages of a partnership or sole proprietorship. The name 'S Corporation' is derived from Subchapter S of the Internal Revenue Code, which stipulates the rules and regulations for this particular type of corporation.

One of the standout benefits of an S Corporation is its ability to sidestep double taxation—a situation that business owners often find themselves in. In contrast to a regular C Corporation where the company's profits are taxed at the corporate level and then again when distributed to shareholders as dividends, an S Corporation's profits and losses are passed through to the shareholders' personal tax returns. This arrangement means the company itself doesn't pay federal income taxes.

However, to qualify as an S Corporation, a business must fulfill certain eligibility requirements. It must be a domestic corporation, have only allowable shareholders (individuals, certain trusts, and estates), and have no more than 100 shareholders. Plus, it must have only one class of stock. Also, shareholders ought to be U.S. citizens or residents, and the corporation cannot be owned by another corporation or certain types of partnerships. 

Advantages of an S Corporation 

Choosing an S Corporation as your business's legal structure comes with a host of benefits. The avoidance of double taxation, as mentioned earlier, is perhaps the most significant advantage. The company's profits and losses are passed onto the shareholders' personal tax returns and taxed at the individual level, potentially resulting in significant tax savings for business owners.

Another crucial benefit of an S Corporation is the limited liability protection it offers to its shareholders. This means that the shareholders' personal assets are generally shielded from the company's debts and liabilities. But be aware that this protection is not absolute, and there are certain situations where shareholders can still be held personally liable.

Ownership interests in an S Corporation are easily transferable through the sale or gifting of shares. This flexibility can be advantageous for business owners who may wish to bring in new investors or pass on their ownership to family members. Furthermore, an S Corporation enjoys perpetual existence—it continues to exist even if the original shareholders leave or pass away, providing stability and continuity for the business. 

Disadvantages of an S Corporation 

While the advantages of an S Corporation are plentiful, it's also essential to consider the potential drawbacks. Firstly, an S Corporation must meet specific eligibility requirements such as having no more than 100 shareholders and only one class of stock. These restrictions can limit the company's ability to raise capital and attract investors. 

An S Corporation cannot be owned by another corporation or certain types of partnerships, which can restrict the company's ability to engage in certain types of business arrangements or partnerships. Like any corporation, an S Corporation is subject to certain formalities and compliance requirements, such as holding regular shareholder meetings, maintaining accurate financial records, and filing annual reports. Failure to comply with these requirements can result in the loss of S Corporation status.

Lastly, while an S Corporation can offer tax savings in terms of federal income taxes, shareholders are still liable for self-employment taxes on their share of the company's profits. This liability can offset some of the tax benefits. 

Seek Trusted Legal Counsel 

At Curiale Hostnik PLLC, we're dedicated to helping you navigate these complex decisions. Whether you're considering forming an S Corporation or need advice on existing business structures, our experienced attorneys are here to assist. We serve clients throughout Tacoma and cities throughout Pierce County including Puyallup, Gig Harbor, University Place, and Lakewood. Reach out to us today to discuss your business needs.