— What’s an “S” Corporation?—
Corporations are generally subject to federal taxation under Subchapter C of the Internal Revenue Code (and this is where the term “C Corp” comes from). However, in certain instances, a corporation can make an election to be treated under Subchapter S of the Internal Revenue Code. Under Subchapter S, a corporation is generally treated as a partnership for tax purposes. What this means is that income and expenses of the corporation pass straight through to the shareholders, which helps to minimize concerns about double taxation. In consideration of such special treatment, however, the shareholders of an S corporation must generally be individuals, and there can’t be more than 75 in a corporation. There are a number of other tricky rules, including when you can decide to form an S corporation.
Why not just use an “S” corporation instead of a limited liability company?
If you’re asking this question, you are showing a pretty high level of understanding about business enterprises. It is true that an “S” corporation generally has the same benefits as your standard corporation, including protection against unlimited liability exposure. At the same time, it has essentially the same tax benefits as a partnership, as profits and loses are passed through directly to the shareholders.
In many instances, an “S” corporation may also be the better way to go. From a practical standpoint, corporations have been around a lot longer than LLC’s. People you’re going to deal with in the business world will be more familiar with the “S” corporation. In fact, in some lines of business, you may not even be able to operate as an LLC. Overall, the “rules of the road” for corporations are better defined than they are for LLC’s, and people are more familiar with them.
However, there are significant limitations to an “S” corporation. In general, all shareholders have to be individuals, and this can be a significant drawback when some of your investors want to invest through business entities, retirement plans or other investment vehicles. The number of shareholders is also limited to 75 or few individuals, and there can be only one class of stock. “S” corporations must also use a calendar year for tax reporting purposes. The rules for making an “S” election and preserving the “S” status of the corporation can be complicated.