An S corporation, or S-corp, is a legal business structure that combines the legal advantages of a traditional C corporation with the tax benefits of a partnership or sole proprietorship. This type of corporation is named after Subchapter S of the Internal Revenue Code, which outlines the rules and regulations for this specific tax designation in the United States. S corporations are a popular choice for small and mid-sized businesses, as they offer limited liability protection and pass-through taxation.
Key characteristics of an S corporation include:
1. Limited Liability Protection: Like C corporations, S corporations provide limited liability protection to their shareholders, meaning the personal assets of shareholders are typically protected from the company’s liabilities and debts.
2. Pass-Through Taxation: S corporations enjoy pass-through taxation, which means that the business itself is not taxed at the corporate level. Instead, profits and losses are “”passed through”” to the shareholders, who report the income or loss on their individual tax returns. This helps to avoid the issue of double taxation often associated with C corporations.
3. Shareholder Requirements: S corporations have certain restrictions on the number and type of shareholders they can have. For example, S corporations cannot have more than 100 shareholders, and they can only issue one class of stock.
4. Legal Structure: S corporations are established as separate legal entities, providing a structure that can outlive its original shareholders. This can make it easier to transfer ownership or raise capital.
5. Ownership Flexibility: S corporations can have individual or corporate shareholders, and they can issue stock to raise capital and incentivize employees through stock options.
6. Formalities and Compliance: S corporations are required to follow certain formalities, such as holding regular shareholder meetings, keeping corporate records, and complying with state-specific incorporation requirements.
It’s important to note that while S corporations offer many advantages, they are subject to specific IRS rules and regulations, and not all businesses are eligible to be classified as S corporations. For example, certain financial institutions, insurance companies, and international corporations cannot be S corporations. Businesses considering this structure should consult with legal and tax professionals to ensure that they meet all the requirements and to understand the potential benefits and limitations associated with this type of corporate structure.