Seeing the company develop and succeed is something that every entrepreneur wants. But as a business starts growing, the tax rate for it may also increase. As a growing business entity, you may face various complexities when the tax season comes. In such cases, entrepreneurs find themselves in the middle of making a huge decision. For some business owners, the obvious option is to consider starting an S corp. That decision is often due to the significant advantages in terms of taxation and the preservation of the business entity structure’s flexibility.
What It Is
S corp is short for subchapter S corporation. Others also refer to it as a small business corporation. Contrary to what some people may think, it is not a business entity structure. In fact, it is a tax code that Congress first enacted in 1958.
The purpose of the introduction of S corps is to encourage and support family businesses and small companies. It eliminates double taxation, which is subjected to conventional corporations.
Aside from the taxation type, it is the same as a traditional corporation or a C corp. If a company has decided on starting an S corp, it will be taxed as a partnership. That means the company will not be paying federal income taxes. Instead, the tax liabilities for the profits and losses of the company will be passed through to the business owners. The company will also be treated as a single entity. The number of people who organized it does not matter.
Here are the main features of this tax code:
- No double taxation
- Pass-through taxation
- Limited liability protection
- Has no more than 100 shareholders at a time
- Only one type of stock
- Transferable stock
- Has to be a domestic business entity
- All owners are US citizens or legal residents of the US
- Business entities cannot serve as owners or directors
While electing S corp status may be beneficial, it is not possible for all types of businesses. The Internal Revenue Services (IRS) does not allow some types of general corporations to elect this tax status. Those include the following:
- Banks
- Insurance companies taxed under subchapter L
- Domestic international sales corporations (DISC)
- Certain affiliated groups of corporations
The Advantages It Offers
Electing S corp status offers various benefits for companies that qualify. Here are some of them:
- Tax Advantages – Gaining tax advantages is one of the things that makes this status appealing. As stated earlier, your company can get a federal income tax exemption. However, that does not apply to capital gains or passive income. Since your company is a pass-through entity, its profits will only be taxed once. It will be on the personal tax returns of the shareholders.
- Asset Protection – An S corp comes with legal protections for the personal assets of the business owners. The assets of the company will be separate from your personal assets, so the shareholders will not be personally liable for any debts and liabilities that the company incurs. Creditors cannot go after your assets.
- Flexible Income Characterization – Owners of S corps can choose how they will characterize their income for tax purposes. As the owner or shareholder, you can consider yourself as an employee of the company and pay yourself a salary. Aside from that, you can also pay yourself dividends from the business or distributions that are tax-free or have tax rates lower than the employee salary. Doing this can help reduce self-employment tax liabilities. However, you have to characterize your salary and dividends or distributions reasonably.
- Transfer of Ownership – Another advantage is the easy transfer of ownership. You do not have to terminate the business. It also does not have any significant tax consequences. It does not require compliance with complicated accounting regulations, either.
Starting An S Corp In Ohio
Choosing to elect S corp status can be beneficial to your company. While the process includes multiple steps, it is not very complicated. Here is a simple guide you can follow:
Step 1: Form an LLC or corporation.
As stated earlier, an S corp is not a business entity structure, so you will have to form an Ohio company first. You can either form a limited liability company (LLC) or a corporation in the state. If you choose to form an LLC, you will have to file the Articles of Organization. If you want to start a corporation, submit a completed Articles of Incorporation. The filing fee for the formation is $99. You may need to pay additional fees if you want to expedite the processing time. Submit the appropriate formal paperwork to the Secretary of State.
Forming a business entity requires you to follow the naming guidelines of the state. Generally, you will have to include the appropriate indicator in your company’s name. You cannot include words that could confuse your business for a government agency. You should also make sure that your business name is distinguishable. Conduct a business entity name search to find out if the name you want to use is still available.
If you are not ready to officially register your business, you can reserve the company name that you plan on using first. File a completed Name Reservation form with the Secretary of State and pay $39. Doing this will reserve the name for 180 days.
Step 2: Nominate a registered agent.
No matter what structure you choose, you will have to appoint a registered agent. They will be in charge of accepting all legal correspondence and documents on behalf of your company. You can appoint an individual resident or a company that is authorized to transact in the state. Make sure you follow the requirements of the state.
Step 3: Get an Employer Identification Number (EIN).
After forming your business, you will have to obtain an EIN from the IRS. Use Form SS-4 Application for Employer Identification Number. You can download a copy of the form from the website of the IRS. The application is free.
Step 4: Issue stocks and prepare initial documents.
If you decide to start a corporation, you will have to issue stocks to the company’s shareholders. This is in return for the shareholders’ capital contributions of cash, services, and property. Most starting corporations issue paper stock certificates. If you choose this, make sure that the corporate secretary records all issuances in the corporation’s ledger with the following information:
- Issuance date
- Name of the stockholder
- Number of issued shares
- Price per share and the total purchase price
- Capital contribution, if it is different from the purchase price
- Stock certificate numbers
Ohio also allows corporations to establish a par value for their stock or to issue no-par value shares. Par value refers to the amount that a specific share can be sold. It is able to be sold at a higher rate but not lower than the par value amount. For example, if the par value is $1 then a share cannot be sold for .75 cents. It does not have anything to do with the actual value of the stock.
To qualify for S corp election, you need to keep in mind the limitations on the capital structure and the nature of shareholders allowed. You should also check with the Secretary of State if there are any additional documents you need to submit.
Step 5: Elect the Subchapter S corporation.
The last step is for you to elect your company as an S corp. To do this, you need to complete IRS Form 2553 and submit it to the said agency. The IRS will evaluate your application to determine if your company is eligible for this tax status. The state also requires you to file a Notice of Subchapter Selection with the Department of Taxation.
This tax code will only change the way that your business entity is treated when it comes to federal income taxes. Your company’s tax obligations with the state will remain. It will depend on the business entity structure you choose when you form your company.
Deciding on electing S corp status for the tax treatment of your company will provide flexibility and protection. However, you need to undergo a process and submit formal paperwork. If you need help in handling the paperwork or ensuring compliance with state obligations, contact our team at DoMyLLC.
