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The subject
of incorporation is probably never complete without discussing
the S-corporation. An S corporation is not a different type
of entity or an entirely a different kind of set up, but merely
an extension of a C corporation. If you wish to be an S corporation
all you need to do is to file a form (form 2553) with the IRS,
and once approved, you are classified as an S-corporation. You
need not file with additional forms or complete any other formalities
when setting up an S corporation.
An S corporation offers the same features as of a regular corporation,
however, federal and state income taxes apply as a sole proprietor
or a partnership. This preferred method is available to all
domestic small businesses. By electing to be an S corporation,
it does not change anything with respect to the liability protection
or providing a shield between the owner/stockholder; it merely
changes the method by which the income taxes are levied. As
discussed above, all income and losses funnel through the corporation
and end up in the individual owner/stockholder's personal income
tax return.
Since, the corporation does not pay the taxes, income and losses
are reported on the personal tax return, thus eliminating double
taxation. Otherwise, the corporation pays the taxes up front
and then distributes the income in terms of dividend to the
stockholder, which is taxed again to the stockholder.
How to set up an S-Corporation? Follow the steps described below:
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1. |
First
file for the incorporation with your state (just
like a regular corporation)
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2. |
Within
75 days after the formation of your corporation,
file form 2553 (Election to be treated as S corporation)
with the IRS
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Are there
any Restrictions or qualifications? Yes:
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1. |
Ensure
that there are no more than 75 stockholders |
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2. |
Non-US
person (any foreigner) is not allowed to become
a shareholder in an S-Corporation
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3. |
Issue
only one class of stock (No preferred stocks or
restrictive stocks) |
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Check
with a qualified accountant to discuss if you have
a special situation, or need to have a qualified
trust becoming a shareholder in your S-Corporation.
As you might have already understood each choice
is a mixed bag of some good news and some bad news.
It is important, therefore, to discuss your situation
with a qualified accountant to guide your through
the maze of entity formation (caution- not all CPAs
and accountants are thoroughly familiar with entity
formalities and tax issues). Our hope is that after
reading this chapter you will be able to decide
which type best describes your situation, and if
you need further assistance you can ask a professional
accountant or an attorney. Here is a summary of
advantages and disadvantages of an S-corporation:
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Advantages:
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No double taxation |
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Stockholders take their share of income or loss
into their personal income tax return |
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Most of the states recognize federal S-corporation
status and also do not impose any income tax at
the corporate level
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It acts like a regular corporation and therefore,
affords the same level of protection as a C-corporation
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The shareholders
recognizing their pro-rata share of corporate profit
pay only the income tax (no social security taxes
levied on the profits)
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Losses
can be utilized to offset other income, and thus
reduce overall taxes |
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Disadvantages:
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No more than 75 stockholders allowed in an S-Corporation
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No foreign individuals or corporations can be stockholder
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Generally, an S-corporation cannot have a C-Corporation
as either a subsidiary or be a subsidiary of a C
corporation (some exceptions apply)
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Not flexible
in allocating income and losses to the stockholders |
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Only
one class of stocks can be issued |
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