When Is An S-Corporation Necessary?

When trying to determine the best way to get your new business off the ground, you will want to compare different entity types. Depending on the kind of company you’re trying to run, some will be more favorable than others. One option that is appealing to many entrepreneurs is an S-Corporation. It has a lot of advantages compared to other entities, but it does have a few limitations as well. Before you check your EIN status, let’s look at what’s involved with forming an S-Corporation.

What’s the Difference Between S and C Corps?

Overall, the primary distinction between these two entities is the fact that one has two levels of taxation and the other one does not.

S-Corps are designed to help small businesses retain a lot of the same benefits of a large corporation without the financial burden of it. Typically, a corporation is taxed on its income, and the employees of the business are taxed on their earnings as well. So, if you’re an owner/operator, this means that you’re getting taxed twice.

S-Corps, on the other hand, allow income to pass through to employees and shareholders, meaning that their taxation covers the business profits as well. Simply put, you’re only getting taxed on what you make as an employee, not what you earn as profits.

Limitations of an S-Corp

Since starting either kind of corporation requires extra paperwork and legal fees, why aren’t all companies listed as S-Corps? Well, that’s because they are limited to how much they can grow. Again, this designation was created to help small business, not multi-national conglomerates.

As an S-Corp, you have to:

  • Be domestic (no international offices or operations)
  • Have less than 100 shareholders
  • Have only one class of stock
  • Have individual shareholders (not other corporations)

Bottom Line

Ultimately, if you’re thinking of starting an S-Corp, just be sure that you can meet these requirements before you verify your EIN number. Also, the IRS will pay much more attention to your taxes, since there is potential for exploitation of this system. In the end, it’s a viable option, but don’t think that it’s a perfect solution.

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