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When you're establishing a business - setting up for yourself, as they used to say - you have a number of tax and legal structures from which to choose. Among them are the sole proprietorship, the partnership, the limited liability corporation (LLC), the C-corp and the S-corp. Of these, the S-Corp is the sole choice that depends wholly on an Internal Revenue Service election. In fact, you can even choose S-Corp status for an LLC. But we're getting ahead of ourselves.
What Is an S-Corp?
An S-corp is a corporation whose owners choose the IRS designation, "Subchapter S." Choosing this designation allows you to sidestep federal corporate taxation. Instead, your shareholders declare company profits - or losses -- when they file their personal tax returns. If you, as the owner/shareholder, also work for the company, the IRS requires that you pay yourself a salary. If that agency determines that your salary is unreasonably low, while the company earnings you report on your tax return are high, you might get into hot water.
Becoming an S-Corp
As you might imagine, with such tax benefits to hand, you have to jump through some hoops to be eligible for Subchapter S designation. First of all, your company must be a corporation. Rules for corporate filing vary by state, but typically, corporate status requires filing articles of incorporation with the appropriate agency, usually the state secretary of state's office. You may also need to file by-laws, to include the schedule for shareholder meetings. Other steps may also be required.
In addition, your company can have no more than 100 shareholders. A married couple - an owner and her husband, for example -- is treated as a single shareholder under IRS rules. You cannot have another corporation act as a shareholder if you want to claim S-corp status. A non-profit organization, on the other hand, is considered an eligible shareholder.
You'll need to get a tax ID number from the IRS. This number identifies you to the agency and is the number your accountant will use when she files your business tax returns.
Moreover, each one of your shareholders must notify the IRS that he has chosen the Subchapter S designation for the company. Whether they work for the corporation or not, all must file IRS Form 2553.
Of course, you'll also have to get the proper licenses and permits for your business. The U.S. government, your state, city and even county may each have a separate set of licensing regulations. Abide carefully by all the rules that apply to your business and its location.
Some states are not as liberal as the federal government when it comes to S-corp taxation. Consequently, if you live in a state such as Massachusetts, you might have to pay state taxes on profits that exceed a certain limit. If your business is in New York or New Jersey, you'll have to file a state corporate tax return just as any C-corporation would.
An S-corp is a corporate structure that offers significant tax advantages. Consult knowledgeable legal and tax professionals to determine if the Subchapter S designation is appropriate for your business.
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