What Does S-Corp Taxation Exactly Entail?

If you’re an entrepreneur trying to structure your startup, you may be reading about LLCs, C-Corps, and S-Corps, and trying to figure out which one is best for you. If you’re looking to start a small, personal business, you may have heard or have been told that S-Corp would be the best choice for you, but you may be wondering what a S-Corp structure actually means. First things first, S-Corp generally refers not to the legal structure of the business, but how the business is taxed. A S-Corp is taxed under Subchapter S of the Internal Revenue Code. Although many business that are taxed under Subchapter S are structured as corporations, LLCs can also be elect to be taxed under Subchapter S. Companies that wish to seek Subchapter S taxation must meet several requirements, including: – Only one class of equity (i.e. no preferred stock classes, although distinctions between voting and non-voting stock may be permitted) – No more than 100 equity holders, who must all be individuals (or certain kinds of estates, trusts, or tax-exempt organizations) – Equityholders must be U.S. citizens, nationals, or resident aliens The main feature of Subchapter S taxation is that it is “pass-through” — all profits and losses of the company are passed through to the equity holders, who must report their share of the profits or losses on their personal tax return. This reporting requirement is regardless of whether the company actually distributes cash to its owners. The pass-through tax structure is in contrast to taxation under Subchapter C (or C-Corp), which is also known as double taxation, because a C-Corp pays the taxes on its own profits or losses, but owners must pay additional tax on any distributions of profits made to them. Furthermore, the pass-through structure of Subchapter S taxation is similar to that of partnership (Subchapter K) taxation, the default taxation method for partnerships and multi-member LLCs. However, Subchapter S has several important differences from partnership taxation. First, partnership taxation permits the partners to allocate the profits or losses among themselves however they wish, including out of proportion to their ownership interest in the business. Under Subchapter S, profits or losses must be allocated in proportion to each owner’s interest. Additionally, Subchapter S allows owners who work in the business to be treated as W-2 employees and take salaries accordingly; partnership generally requires partners to take distributions of the company’s profits or losses. A CPA or tax attorney can help assist you in your company formation by advising you on the various taxation options available for each company structure and helping you to determine the best tax structure for you and your business.

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