S Corporation Requirements & Filing Essentials

entrepreneur researching s corporation requirements before filing

S Corporations offer tremendous advantages to owners over other business entity types. They save their shareholders considerable amounts of money on their taxes, offer more significant business validity with customers, and shield owners from liabilities.

Reaping these benefits comes with a bit of a cost in the form of more onerous business and tax filing requirements, but with the right amount of knowledge, you can easily navigate the S Corp requirements. Read on to understand S Corp requirements and filing essentials.

Understanding S Corporations

Before delving into S Corp requirements, a quick primer on S Corps might be helpful.

A Subchapter S Corporation is an entity recognized and filed with the IRS. If the company is initially formed as an LLC with the state, it can then be converted into an S Corp with the IRS using Form 2553 within 75 days of the business formation to qualify as an S Corp in its first year.

An S Corp has several key components that separate it from an LLC or partnership. The main components are:

  • The business ownership structure is through shareholders, of which the S Corp is allowed to have up to 100.
  • The business must perform like a C Corp in many ways, like holding annual board meetings even if it is a board of one.
  • An S Corp files its tax form with the IRS using the Form 1120-S.
  • Any owner working within the business with over 2% ownership avoids payroll taxes on dividends and distributions so long as they pay themself a reasonable wage.

However, an S Corp is like an LLC or partnership in that all profits or losses “pass-through” to the owners, whereas a C Corp pays its own taxes at the corporate tax rate of 21%.

Filing Essentials for S Corporations

To file an S Corp, articles of incorporation must be created and filed with the appropriate state before the shareholders sign Form 2553, which is then filed with the IRS. The board of directors will need to be appointed, annual meetings scheduled, and the corporate bylaws written and filed.

entrepreneur researching filing essentials for S corporations

Now you’re off and running. Well, that is, so long as the company meets additional requirements.

Meeting Eligibility Criteria

To qualify for S Corp status, the company must meet certain criteria.

Being a Domestic Corporation

To qualify as an S Corp, the corporation must be domestic, meaning it is domiciled within the United States. The United States includes Washington D.C, the five US territories, and the 50 states.

Eligible Shareholders

To be an eligible shareholder of an S Corp, one must be a living person who is a US resident or resident alien. Other business entities, such as LLCs or corporations, may not hold stock in the company.

Some organizations that are not living persons are allowed to have ownership in an S Corp, including some trusts and tax-exempt organizations like non-profits.

Limitations on Shareholders

An S Corp is limited to 100 shareholders, whereas a C Corp has no limitations on shareholders [1]. However, a loophole exists that families and their estates may count as a single shareholder.

Single Class of Stock

Unlike C Corps, which may have multiple classes of stock, an S Corp is limited to a single class of stock, which must convey identical rights to proceeds from distributions and liquidations. Voting rights are allowed to differ, though.

Maintaining Compliance With Business Restrictions

Several restrictions exist that can cost the company its S Corp status, including:

  • If the S Corp earns more than 25% of its earnings from passive sources like rents, annuities, stock sales, interest, or royalties for three consecutive years.
  • If the corporation is an ineligible entity, such as some financial institutions, insurance companies, or exporters of goods that are already receiving special tax treatment.

State Specific Requirements

The state in which the S Corp is incorporated and the states where it is registered as a foreign corporation will tend to have state-specific requirements that must be met to retain S Corp status. Some of those requirements could include additional state filings, fees, or taxes.

Tax Considerations for S Corporations

As previously mentioned, an S Corporation is a pass-through entity in which the profits or losses pass through the owners per their percentage of stock ownership, and no payroll taxes are paid on dividends and distributions paid beyond reasonable compensation. Once passed through to owners, the individual’s tax rate applies instead of the corporation being taxed directly by the IRS.

Profits and losses passing through to the shareholders don’t necessarily mean the S Corp will pay no taxes. The company could be liable for:

  • Income that is taxed at the state or local level.
  • The company portion of employment taxes (Social Security and Medicare taxes).
  • Federal unemployment tax (FUTA).
  • Estimated taxes that are required to be paid quarterly if the company expects its tax liability to be $500 or greater when its Form 1120-S is filed.
  • Excise taxes that are applied to certain services, business activities, and goods. Excise taxes are imposed on things such as the sale of fuel, heavy trucks, tobacco, and indoor tanning.[2]
entrepreneur reaching out to a tac professional to discuss filing their 1120-S tax return

Additionally, S Corps must file their Form 1120-S tax return by the 15th day of the third month after their year-end but are allowed to file for an extension until September 15th. If a due date falls on a holiday or weekend, the due date is often moved to the following Monday.

Owners must also pay themselves reasonable compensation, or they could subject the corporation to unnecessary taxes and penalties.

Advantages of S Corporations

An S Corp comes with some fabulous advantages that include:[3]

  • Shareholder asset protection from company liabilities.
  • No payroll taxes on distributions or dividends for owners paying themselves a reasonable wage for their contribution within the business.
  • An easy transfer of ownership.
  • Pass-through taxation (avoiding double taxation).
  • Enhanced credibility with customers.

Disadvantages of S Corporations

Just as an S Corp offers some incredible benefits to its owners, it comes with some trade-offs in the form of:

  • A more complicated formation and the potential for higher yearly corporate form maintenance expenses.
  • Closer scrutiny from the IRS.
  • Tax filing obligations are more complex and must be met, or there is a chance of losing the S Corp status, albeit this is quite rare.
  • Due to the single class of stock, an S Corp doesn’t have the flexibility to allocate income or losses to specific owners like an LLC or partnership.
  • Most fringe benefits are taxable.

An S Corp Is an Excellent Choice for a Corporate Form

Despite the few limitations, higher standards for its maintenance and tax filing, and some additional taxes, the savings on payroll taxes while still being a pass-through entity are outstanding benefits. S Corp owners that pay themselves a reasonable wage will avoid 15.3% of payroll taxes on their distributions or dividends while not being subjected to the double taxation of a C Corp.

Overall, an S Corp provides owners with asset protections while saving them considerable money.

RC Reports provides reasonable compensation analysis for S Corp business owners and accountants to ensure they save money on payroll taxes without risking IRS penalties.

Contact RCReports today for a free demo.

Sources

1. S Corp vs C Corp – Differences & Benefits. (2024, January 23). S Corp vs C Corp – Differences & Benefits. https://www.wolterskluwer.com/en/expert-insights/s-corp-vs-c-corp-differences-benefits

2. An overview of excise tax. (2024, January 23). An overview of excise tax. https://www.irs.gov/newsroom/an-overview-of-excise-tax

3. S Corporation (S Corp) Advantages & Disadvantages| BizFilings. (2024, January 23). S Corporation (S Corp) Advantages & Disadvantages| BizFilings. https://www.wolterskluwer.com/en/expert-insights/s-corporation-advantages-and-disadvantages

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