The Fifth in a Series of Articles for Entrepreneurs
by Bukre Ayan
Small business corporations and LLCs can elect to be treated as a ‘pass-thru entity” for tax purposes. They are sometimes called “Subchapter S Corporations,” “S-corporations” or “S-corps”.
In a regular corporation (“C-corp”) setting, corporations pay taxes on their corporate income. Then, if any after-tax income is distributed to shareholders, they will need to report these dividends as income and pay taxes on it, as well. Conversely, pass-through entities do not pay taxes on income at the business level.
The S-Corp (and LLC) will report their corporate income, losses, and deductions, and then each shareholder or member reports its pro-rata share on their personal tax returns. This avoids double taxation of the corporate income. However, the owners should know that, unlike C-corporations, they will need to pay taxes on the earned business income even if it’s not distributed to them.
S-corp election is made at both the IRS and New York State levels. Some of the important IRS requirements to consider are:
i) S-corps must have only one class of stock (i.e., shareholders do not have priority over each other)
ii) Non-resident aliens cannot be the shareholders of an S-Corp, and S-Corps cannot have more than 100 shareholders.
(For more information, please see the link https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations)
After the IRS’s approval, the business needs to file an S-Corp election with the NY Department of Taxation and Finance for State tax purposes. On the other hand, NY applies mandatory S-Corp treatment to eligible corporations even though the election at the State level has not been filed. (Please see the link for more information https://www.tax.ny.gov/bus/ct/s_corporations_post.htm.)
As it’s explained above, an S-Corp is formed like a NY corporation and operates like a C-Corp. For example, similar to the C-Corps, S-Corps are required to file their biennial statements with the NY Department of State. The same regulatory annual – special meeting requirements which apply to C-Corps apply to them. Both the C-Corps and the S-Corps are owned by their shareholders, operated by the board of directors, and the officers oversee the daily businesses. (For more information on how to form and operate your entity, please see our previous articles).
Some of the advantages of an S-Corp
The income of an S-Corp is not double taxed. Also, the losses of an S-Corp pass through the shareholders and can be claimed on the shareholders’ individual tax returns.
The federal accumulated earning tax that is imposed on some of the retained earnings of the C-Corps does not apply to S-Corps. Also, S-Corp business earnings are not subject to some federal taxes that apply to sole proprietorships, partnerships, and LLCs.
S-corps are not subject to a corporate alternative minimum tax liability which is a calculation system that may require C-Corps to pay higher taxes.
Some of the disadvantages of an S-Corp
While income and losses pass through shareholders based on their pro-rata shares, reporting S-Corp taxes can be more complex than reporting LLC taxes.
A shareholder-employee possessing more than 2% ownership in an S-Corp is not allowed to enjoy tax advantages of most of the fringe benefits.
S-Corps are not flexible like C-Corps in terms of their internal structuring. As stated above, S-Corps must have only one class of stock, cannot have more than 100 shareholders and cannot be owned by a nonresident alien.
Apart from the above descriptions and the limited list of the advantages and disadvantages of an S-Corp, there are several other factors that business owners should consider before making an S-Corp election. To see whether the S-Corp election is the best option for you and your business, please consult with your attorney and/or your accountant.
(For more information, please consult an attorney. Our next article will be on Not-For-Profit-Corporations. To see the previous articles, please visit our website at https://www.reedbusinesslaw.com.)
Please be advised that this article is not intended to provide you with any legal advice, and prior results do not guarantee a similar outcome.
Ms. Bukre Ayan is an international associate with the firm of Reed CNY Business Law, P.C., specializing in business, immigration, and real estate law. Bukre received her LLM degree from Syracuse University College of Law in 2020 and is admitted to practice in both New York State and the Republic of Turkey. The Spanish translation was done by Ms. Sylvia Espinosa. Sylvia is a legal intern Reed CNY Business Law, P.C. She is a recent LL.M. graduate at Syracuse University College of Law, and she graduated with a Bachelor of Law degree from a Mexican University.
If you have any questions or comments about these articles, contact Ms. Bukre at (315) 558-0642, or firstname.lastname@example.org. You may also visit www.reedbusinesslaw.com.
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