Like a regular corporation, an S Corp is a collection of stockholders who share company ownership. The subchapter S refers to the IRS code. This is the only real difference from a C Corp – how taxes are calculated. All of the other complications of starting a corporation remain the same.
Starting an S Corp
Articles of incorporation and filings with the Secretary of State remain the same. Fees and paperwork vary a little between States. There may be a real advantage in choosing a State with a ‘friendly’ business environment to incorporate in.
For small businesses that incorporate, some of the filings maybe ‘cut and paste’, but the larger or more profitable a corporation becomes, the more it is wise to have expert advice. States will require a minimum number and type of officer to run the corporation. Each officer will have specific responsibilities under the law.
Recordkeeping is the same for an S Corp as a C Corp except for taxes (see below). Like a C Corp, a name search must be performed to make sure the corporation name is unique.
S Corp Taxes
The reason an S Corp is attractive is that instead of only paying dividends (which are taxed twice) an S Corp allows money to flow to the owners in lieu of wages. This means that profits can pay the salaries of owners who work in the corporation. The wages must be on par with what someone else would be paid to do the same job.
Handling salaries this way means that separate taxes on wages are avoided. The corporation doesn't have to pay both a tax on the profits as well as the withholding (social security, Medicaid) that would otherwise be added in. The bottom line is that high taxes on corporate profits are avoided. Currently, these taxes amount to as much as 35%.
State tax rates vary. Since many of the profits flow through as individual income for an S Corp, there may not be any State taxes at all. This is one reason why Nevada (with no individual income taxes) is a popular choice for incorporating.
S Corp Liability
The corporate shield remains in place for S Corps, with one important difference. A regular corporation is formed with the express purpose of keeping the shareholders at arm's length from the company's daily operations. But an S Corp has owner-employees. This means that an action by an employee of the corporation can be used to sue that employee personally.
Even though the shield is in place, it can be penetrated in some circumstances. This usually requires some obviously negligent or criminal act. In general, an S Corp does provide as much protection from liability that a C Corp does.
Corporation Credit and Financing
The ability to issue stock to raise capital remains with an S Corp. Personal assets do not have to be put at risk. Investors and private equity can be sought instead of relying on personal credit alone.
S Corps are also vulnerable to being bought or taken over if the stock is purchased by a third party. Selling an S Corp involves all of the considerations in selling a C Corp. Starting an S Corp is advisable when the owner is also a main contributor to the work product. It has the advantages of a corporation with the tax benefits of a sole proprietorship.