Many businesses start life as an s-corp and when profitable become c corps to benefit from income splitting and fringe benefits. Alternatively they form an LLC which is simpler to form and operate but offers the same personal liability protection.
S corps don’t pay federal corporate income tax but they do have to file a tax return – Form 1120S reporting the profits or loss of the business. K-1 forms are then given to the shareholders who report the figures on their individual tax returns.
Salaries and bonuses paid by your S-corp are subject to income tax and self-employment tax but dividends are only subject to income tax – there is no self-employment tax.
State Taxation
•Most states tax s-corps the same as the Federal Government does.
•The shareholders are subject to state income taxes on their share of the profits.
•Some states require you to make an extra S-corporation election.
•Some states do not recognize s-corporations and treat s-corporations like c-corporations.
Your s-corporation will still be an s-corporation for federal tax purposes but not for state tax purposes. This means you will have to file a state tax return.
Some states such as California, New York and New Jersey tax both the s-corporation and the shareholders – a form of double taxation. However, the corporate tax rates are usually modest.
If you want to set up an s-corporation contact your state income tax office and ask them whether a separate state s corporation election is required and how s-corporations are taxed.
Losses
Like an LLC, S-corporation losses flow through to the individual shareholders and can offset your other income. However, you cannot deduct a loss greater than your stock basis.
Your stock basis is generally the total money and property you put into the business.
To qualify for S-Corp status:
•No more than 75 shareholders are allowed. Venture capitalist are often put off by this sort of set up.
•Non US citizens are not allowed to be shareholders
•Individuals, certain partnerships and other S Corporations can be shareholders but S Corporations cannot be owned by C Corporations, other S corps, many trusts, LLCs and partnerships.
•S Corporations can only issue one class of stock - common stock. Your ownership percentage determines your percentage of the pass through income. This is different to LLCs where the percentage of pass through income does not have to be the same as ownership percentage.
•Your interest is freely transferable, which means you can sell it without the approval of other shareholders. LLC members need approval from the other members.
•Your ownership interest is easy to sell or transfer to family members. This can be time consuming and costly for a sole proprietor or partnership. With corporations your ownership of all the business assets is wrapped up in the stock you hold and all you have to do is sign over your stock.
•The corporate structure allows you to easily sell shares in the company through stock offerings. This is useful for attracting investors and employees.
Source: http://www.ArticlePros.com/author.php?Nick Braun EA PhD
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