What Is an S Corporation?

January 29, 2021
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When starting a business, you’ll have to choose from one of the many available legal structures. An S corporation (S corp)—commonly utilized by small businesses—is one that offers unique tax benefits and protections for its owners and shareholders. Namely, unlike the default corporation (C corp), it enables “pass through” taxation, a potential benefit, along with the same corporate protections.


If you want to take advantage of these benefits, or learn more about what is a S corporation business, this guide has you covered. Below, we will break down exactly what S corps are, how they compare to the different types of business ownerships (including other types of corporations), and how to succeed as an S corp business entity.


S Corporations: What You Need to Know

The DC-based advocacy group S-Corp charts the history of the S corp, beginning with its initial adoption in 1946, as a much-needed alternative for small business owners. Prior to the S corp, you would have to choose between the protections and bureaucracy of a traditional C corp, or the flexibility and liability of a sole proprietorship or partnership structure (explained further below).


The S corp offered a new path. The defining qualities of an S corp include:


  • Separation of corporate and personal assets, which enables insulation from or limitation in liability for shareholders, relative to debts and obligations of the business.


  • “Pass through” taxation, enabling shareholders to claim corporate profits and losses on personal taxes only, rather than the double taxation of a C corp (see below).


Like C corps, S corps have rigid formal requirements as a legal entity. All businesses at a corporate level need to document their directors and officers, as well as the bylaws for regular meetings. Bylaws then need to be followed, with meetings documented in minutes, which must be made available upon request should their legal entity be audited.


In addition to these general corporate requirements, there are also special qualifications for S corporation status. Per the IRS, these include:


  • The corporation must remain domestic
  • Shareholders must be US citizens
  • Some US-based trusts or estates may own shares
  • There can be no more than 100 shareholders total
  • Only one class of stock can be offered


S Corp Pros and Cons: Is It Right for You?

As noted above, S corps are commonly used by small to medium-sized businesses. They offer a “happy medium” between the burdens of a C corp and the flexibility of a sole proprietorship or partnership. The pros and cons include: 


Pro: 

  • Limited liability – Protection for shareholders on debts and legal obligations incurred by the business. This is not unique to an S corp, nor does it apply to all liability. Illegal activity, for example, can pass through to personal liability.


  • “Pass through” taxation – Shareholders can avoid the “double” taxation of a C corp, wherein profits are taxed both when the business earns them and when they are distributed to shareholders. This is unique and one of the primary benefits of operating as an S corporation.


  • Lower self-employment taxes – Rather than paying Medicare and Social Security taxes on the business’s net earnings, shareholders can pay these self-employment taxes on only their own compensation. This is another unique reduction in tax burden.


Con: 

  • Limited availability – S corps are not recognized and taxed in the same ways in all states. Some do not recognize S corporation status, and others entail different profit thresholds for pass through taxation, above which corporate taxes may still apply.


  • Restrictions on growth – The qualifications for shareholders can limit who is able to invest in your business which can slow down growth. Venture capitalists may not be able to invest, or may choose not to, given the limitations.


Based on these factors, an S corp is likely a strong option for your business if it is available to you and if your shareholders value the benefits of “pass through” taxation. However, since your potential for rapid growth as an S corp is capped, those seeking larger profits in the short term might prefer another option. 


Typically, a business owner will decide between one of a few types of corporate structures. 


Other Common Business Structures

Per the Small Business Association (SBA), some of the other most common structures include:


  • Sole proprietorship – The simplest and smallest business structure, a sole proprietorship is the default designation for a single entrepreneur’s business activities, even if he or she neglects to officially register a business. There is no separation of personal and business assets, so the sole proprietor can be held personally liable for business debts.


  • Limited partnership – A limited partnership is a step up from sole proprietorship for two or more business partners. One “general” partner is charged with the majority of control over the business, as well as liability. Other partners enjoy limited liability.


  • Limited liability partnership – Also known as an LLP, a limited liability partnership extends limited liability to all partners. As such, individual partners are not responsible for other partners’ actions and liabilities, nor those of the LLP as a whole.


  • Limited liability company – More commonly known as an LLC, this company is a happy medium between sole proprietorships and corporate structures. There is limited liability, for one or more owners limited liability, as well as the option to “pass through” profits or losses to personal taxes. LLCs also don’t require the formal structure of a corporation. 


What all these non-corporate structures share is a relatively simple scope that does not require formal designation of directors and officers, meeting schedules, etc. However, they also lack a major incentive of corporate status: enhanced legal protections and opportunities for rapid growth.


Other Corporate Business Structures

The default form of a corporation is a C corp. Unless stated otherwise, a business referred to as a “corporation” is likely a C corp. The other most common kind of corporation is an S corp. As noted above, the biggest difference between a C and S corp is the latter’s ability to pass profits and losses through to shareholders’ personal taxes, like an LLC or other non-incorporated business structure. On the flip side, C corps can have more than 100 shareholders, meaning the company can go public.


Beyond S and C, there are other niche corporate structures, including:


  • Benefit (B) corp – Taxed as C corps, B corps are different in their mission, namely they have a commitment to a public good. In practice, this entails heightened accountability burdens to maintain B status, which can boost reputation among conscious-minded investors.


  • Close corp – A close or “closed” corp, also known as a private company, is typically run by a small group of shareholders. While definitions vary by state, close corps are typically free from some formal corporate requirements, but cannot sell shares publicly.


  • Nonprofit corp – A nonprofit, like a B corp, is beholden to a mission that benefits the public. However, by definition, it does not exist in order to generate profit. As such, nonprofits are tax exempt, but still require formal structure (directors, meetings, etc.).


What You Need to Launch as an S Corp

In order to launch your business as an S corp, you’ll need to go through all the regular processes of incorporating any other business, as well as the special application for S corp status. 


To simplify matters, there are two basic steps to follow to launch an S corp:


  • Filing articles of incorporation – This state-level application documents all the basic information about your business, including factors like its name, directors, and other formal structural requirements detailed above. Drafting of the articles can be time consuming, and submission may necessitate a fee, depending on your state.


  • Filing as an S corp with the IRS – In particular, this means filling out and submitting Form 2553 to the IRS. The form calls for a declaration (and proof) that your business meets the requirements for S status, as detailed above. This is facilitated by the IRS’s Instructions for Form 2553, an accompanying document that details everything you need.


At launch, and throughout the life of your S corp, securing funding will be crucial to your success. This is especially true for S corporations, which can have a harder time attracting investments from a shareholder due to their limitations. One of the most powerful options for funding your business can be its line of credit: the right one can increase financial flexibility and maximize savings.


Power Your S Corporation with Ramp

An S corporation business entity is a unique structure that’s often a great fit for smaller businesses. If you prioritize greater flexibility in taxes, balanced by the robust legal protections and formal requirements of a corporation, it might be the perfect structure for you. 


To match your growth, Ramp’s corporate card offers S corps and all companies the ability to spend on their own schedule and take control of their expenses with a robust spend management platform. Pair this with automatic cost-saving opportunities and a vendor management control center—it’s a corporate card and a finance team’s best friend in one. 


Whatever structure you choose, Ramp is here to power your business’ success.


Sources

Business News Daily

Houston Chronicle

Investopedia

Internal Revenue Service

Nerdwallet.
Small Business Association

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