First off, what is an S-Corporation?
Well, an S-Corporation (also known as the S-Corp) is a special type of corporation that draws its designation from subsection S of the tax code. To start an S-Corp, a small business owner starts a C-Corporation in the state where it is headquartered, then files for S-corporation status with the IRS. While an-S Corporation is similar to a C-Corporation, it has different income and self-employment tax regulations.
One of the biggest and best differences between an S-Corporation and a C-Corporation is the pass through taxation. Like an LLC, an S-Corporation does not pay taxes at the corporate level. Any income or losses are reported only on the personal income taxes of the business owner’s. As a result, this avoids the issue of double taxation that affects C-Corporations. Since net losses are also passed through, the individual shareholder may be able to reduce his or her tax liability by offsetting other income with any S-Corporation losses.
Though, there is an important caveat to keep in mind: any shareholder who works for the company must pay him or herself reasonable compensation. Basically, the shareholder must be paid fair market value, or the IRS might reclassify any additional corporate earnings as “wages.”
If pass through taxation sounds good to you, consider the S-Corporation for your new business. And no pressure, if you end up deciding you’d like to stick with a regular C-Corporation after declaring your business as an S-Corporation, you can easily drop the S-Corporation status with the IRS.