What is an “S” Corp?

What is an “S” Corp?

So you want to incorporate in California. [Do not pass go if you would rather incorporate in Delaware – instead read this blog].  Which Corporation should you choose to incorporate under?

S Corporation:  What’s in a name?

An S Corporation (also known as S-Corp) gets its name from the Chapter 1, Subchapter (S), Part I of the Internal Revenue Code. The Code defines an “S Corporation” as a small business corporation for which an election under Section 1362(A) is in effect for the year.

What is it?

Corporation elects a special taxation status with the IRS. In order to elect S Corporation status, you must file Form 2553 with the IRS. The form must be re-filed each year with the IRS.

Requirements:

A corporation may elect to be treated as an S Corporation only if its:

  1. A domestic corporation,
  2. Has no more than 100 shareholders,
  3. Its only shareholders are individuals, estates or exempt organizations,
  4. And has only one class of stock.
  5. Owners of the corporation must be US Citizens or Residents.
    1. S Corporations cannot be owned by C Corporations nor LLC.

Corporations that are ineligible to elect S Corporation status include financial institutions, insurance companies, corporations to which the 936 election applies, or former Domestic International Sales Corporation.

Taxation Benefits:

S Corporations elect to pass corporate income through to the shareholders for federal tax purposes. This avoids the double taxation on the corporate income on both the corporate and the individual shareholder level. The profits and losses of the business are instead “passed – through” the business and reported on the owner’s’ personal tax returns. Any tax due is paid by the owners on an individual level.

Disadvantages:

The S Corporation cannot accept investment by a Venture Capital (VC) Firm since the VC’s are typically structured as a corporation or limited partnership. The S Corporation may not have non-US citizens as shareholders.

S Corp and Startups:

Should your startup be an S Corporation? Generally speaking you don’t want your startup to take the S Corporation Election since it will limit your ability to offer stock to international employees and your startup can’t take investment. However some startups make the S Corporation Election during the first few years if they are operating at a loss, this allows the shareholders to personally take the capital loss on their taxes. You can then switch to a C Corporation later when your startup is looking for financing, or to add more shareholders.

Protection:

S Corporations offer its owners limited liability protection. The owner of the business isn’t going to be held responsible for more than his investment in the company.

Corporate Formalities must be observed when electing to incorporate as an S – Corporation.

If you would like to speak to an experienced San Francisco business attorney who can advise you how to form an S Corporation, contact Sutter Law Firm for a free consultation.

 

 

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