Generally speaking, when somebody files to create a business, they are filing as a corporation (C-corp) or an LLC. Either one can be registered with the federal government as an S-corp. An S-corp is simply the tax status with the federal government. The status provides tax benefits, depending upon the structure of the business and salaries of the business owners. If you jeopardize your s-corp status, you may be taxed as a C-Corp. This blog will explain how to protect your S-Corp.
To qualify as an S-corp, and take advantage of the tax benefits associated with an S-corp, a few elements are required. First, an S-corp is not allowed to have more than one hundred owners. This means that a C-corp that is registered as an S-corp could not have more than one hundred shareholders. An LLC cannot have more than one hundred members/owners. Simply put, there must be one hundred or fewer owners of the business in order to have S-corp status.
Additionally, none of the owners can be foreign nationals who are not in the US or not legally in the US. In order to qualify for S-corp status, the owners must be U.S. citizens or legal residents.
An additional requirement is that there be no preferred status for any owner, such as preferred stock or disproportionate LLC distributions or benefits. Everyone has to receive distributions according to their percentage of ownership, whether LLC or C-corp. Distributions according to stock ownership have to be in accordance with common stock principles, where everyone receives dividends according to the number of shares they hold. Distributions of profits to LLC members must be in proportion to their ownership in the LLC. Separate salaries can be received for work provided for the LLC, or for the corporate entity, which is treated separately. In fact, this is the area where S-corps are most advantageous for tax purposes.
Additionally, the owners must be individuals, or trusts held by an individual. There are exceptions for charities. Generally speaking, the owners of the business (members or shareholders) cannot include a business entity as an owner.
If an S-corp status is received from the federal government, it is important to preserve that status. If the S-corp status is lost for any reason, it likely will not be obtained again for five years. During that time, the federal government will tax the entity as a C-corp, even if it was originally an LLC. The loss of an S-corp status will result in transformation from what is generally the most favorable tax status to the least favorable tax status.
If you have any questions about obtaining an S-corp tax status, it is best to consult with an accountant and legal counsel to ensure that you are in compliance. Additionally, an S-corp would still need to comply with all other legal issues, including employee rights, independent contractor agreements, licensing issues, contracts, sales documents, bylaws or operating agreements, and all other legal matters.