S-corporations are pass-through entities. This means that all of the income is passed through to the owners or shareholders. This also means that the s corporation itself is not subject to federal income tax. Rather, shareholders will be taxed on their own dividends from the total income.
By being able to work with the benefits of being a corporation, and combining that with the benefits of an s-corp, it can provide the opportunity for a greater amount of profit. Despite this, there are various rules that a corporation must adhere to, should they want to qualify for s corporation status.
What is the Difference Between S Corporations and C Corporations?
S-corporations differ from C-corporations in that they receive more tax benefits. S corps are considered a “flow-through tax entity”. This is similar to a sole proprietorship, partnership, or LLC.
As a flow-through tax entity, the profits and losses of an S-corporation are given straight to the shareholders. This is then declared on those shareholder’s personal tax returns, rather than through the corporation.
Advantages and Disadvantages of an S Corp
Here are a few advantages and disadvantages of starting an S Corporation in Delaware.
- Limited liability
- No state residency requirements
- Pass-through taxation
- Privacy protection
- Income-splitting potential for shareholders and employees
- Shares are subject to seizure and sale in court proceedings
- Maximum of 100 shareholders
- All shareholders must be U.S residents
- Shareholders holding 2% or more of the company’s shares cannot receive tax-free benefits
- High-income shareholders will pay more taxes on their distributions
- Not suitable for estate planning vehicle
- Any mistake can revert the s corp back to c corp status, meaning double taxation
- Limited to one class of stock only
How is an S Corp Taxed?
When an S-Corp is taxed, it occurs as a pass-through entity. This means the company does not file and pay taxes. Instead, the owners must show the earnings on their personal return.
S Corp Taxations
There are two main forms of s corp taxations, these include:
- Payroll taxes
- Franchise Taxes
Payroll Taxes in Delaware
Payroll taxes in the state of Delaware are taxed on a sliding scale. For those who make $20,000-$25,000, the rate is 5.2%, while those who make $25,000-$60,000 are taxed at 5.55%, and those who make over $60,000 are taxed at a rate of 6.6%.
Franchise Taxes in Delaware
Franchise taxes for a corporation in Delaware is based on the corporation type and the number of authorized shares the company has. The minimum tax is $175 for corporations using the Authorized Shares method, while the minimum tax is $400.00 for corporations using the Assumed Par Value Capital Method.
All corporations using either method will have a maximum tax of $200,000 unless they have been identified as a Large Corporate Filer. In this case, the tax may go as high as $250,000. Taxpayers owing $5,000.00 or more pay estimated taxes in quarterly installments with 40% due June 1, then 20% due by September 1, and 20% due by December 1. Anything left over will be due March 1.
Is an S Corporation Right for You?
Corporations provide several advantages, such as the ability to provide preferred shares. Despite this, typically a corporation must pay its own taxes. This leads to double taxation. S-corps always avoid double taxation, which is one of the main benefits of forming.
Who Should Start a S Corporation?
S corps are typically best for any company that qualifies. In order to qualify for s corp status, your corporation must adhere to the following:
- Be a domestic corporation.
- Shareholders must be United States residents
- Have no more than 100 shareholders
- Have only one class of stock
Who Should NOT Start a S Corporation?
Although many corporations may benefit from passing income through to shareholders, it can be a disadvantage in some instances. If the business is profitable, then the shareholders will be required to pay income tax on their share of the profits. Sometimes though, even if that money is not distributed to them, they will still pay taxes. This is a major issue.
In a C-Corporation, profits can be used to expand the business. In this instance, shareholders are not required to pay taxes until distributions are made. Additionally, in an S-Corporation, fringe benefits may not be deductible as they would be in a C-Corporation. These losses may pass through to the shareholders, but they also may not be deductible.
Why would an LLC elect to be taxed as an S Corporation?
Because the LLC is most flexible in terms of taxation, an LLC is able to choose any tax election it wants. There are reasons why an LLC would choose to be taxed as an S corporation over other forms of taxation. Oftentimes, an S-Corp election provides the best tax savings.