What is an S Corporation

Written by on June 15, 2012 in Money - No comments | Print this page

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When launching a business start up there are three types of legal structuring that most people should consider: an LLC, a C Corporation and a S Corporation. While most people have a basic understanding of LLCs and C Corps, the S Corporation is often misunderstood. This article atempts to explain what an S Corporation is and what its advantages and disadvantages are.

An S Corporation has characteristics between an LLC and the more common C Corporation. Like the two just mentioned business structures an S Corp provides protection through limited liability for its investors.

An S Corp is similar to an LLC in that it avoids double taxation by having a “pass-through” tax structure. This means that the income earned by these two structures is taxed as personal income for their investors, unlike a traditional C Corp the business itself is never taxed.

 S Corp vs LLC

  • S Corps differ from LLC is than they are much more restrictive:

  • The complicated record keeping and legal procedures that are required of a C Corp are also required of an S Corp, LLCs have much less stringent rules.

  • An S Corp can have at most 100 shareholders, LLCs can have an unlimited number.

  • An S Corp must be managed by payed directors or officers. Shareholders can be the management, but they must be registered as such. LLCs can be owner managed.

  • An S Corp must pay its shareholders based on their percentage of ownership. LLCs owners can divide profit up how they like.

  • If an S Corp is owned and managed by the same person then that person is subject to the same self-employment tax as a LLC owner-operator. The difference is that an LLC owner must pay the self-employment tax on the entire business net earnings while the S Corp manager only pays taxes on their salary. An S Corp can have significant savings over an LLC.

  • S Corps are legally required to pay taxes on a pay-as-you-go tax system that is paid on regular intervals through out the year. An LLC only pays their taxes only once a year.

The biggest differences between an S Corporation and a C Corporation are:

  • The S Corp has the pass-through tax system that is discussed above.

  • The S Corp has a limited number of shareholders.

  • With an S Corp all of the businesses earnings are taxed every year, a C Corp shareholder only pays taxes on money distributed as dividends. This means that C Corporations can hold onto their profits to invest in future capital, while it is smarter for S Corporation to distribute all earnings.

Should I choose S Corporation or a Limited Liability Company?
Multiple business forms exist choosing
The difference between S Corporations and LLCs are varied and extremely nuanced.  LLCs are safer for most people starting their own business as their are fewer legal requirements, but in certain situations an S Corp may be the preferable choice for tax purposes.   It is strongly recommended that you speak to an expert before filing any paper work.

Image courtesy of FreeDigitalPhotos.net

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About the Author

Matt Brand

Matt Brand is QLR’s money saving expert. His experience with credit cards and student loans have made him take a strong interest in personal finance, saving money and sharing his knowledge. He is passionate about teaching others how to avoid the trap and make smart financial decisions. View all posts by Matt Brand.