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Dothan, AL Law Blog

Friday, March 29, 2019

Things to Consider When Choosing to Form an S Corporation

Do you have a creative idea for a business? Do you have a skill that you know residents in your community need? Unfortunately, there can be many hurdles to overcome before your doors open. 

If you are planning on starting a business, one of the first factors to consider is what type of corporation you plan on creating. The Internal Revenue Code allows for two different levels of corporate tax treatment. Subchapters C and S of the code define the rules for applying corporate taxes. An S Corporation is a popular type of corporation where the owner elects to be taxed as a flow-through entity by the Internal Revenue Service (IRS) and can have many benefits as a business owner. To help you learn more about this type of corporation, we want to share with you five things to know when choosing to form an S Corporation.

First, to qualify for subchapter S treatment, certain criteria must be met. Subchapter S Corporations meet certain requirements that allow the business to insulate shareholders from corporate debts but avoid the double taxation imposed by subchapter C. To qualify, corporations must be domestic, not affiliated with a larger corporate group, have no more than 100 shareholders, only have one class of stock, not have any corporate or partnership shareholders, and not have any nonresident alien shareholders. Further, after a business is incorporated, all shareholders must agree to subchapter S treatment prior to electing that option with the IRS. 

Next, understand what is needed to form an S corporation. First, file a document that creates an independent legal entity with its own name, purpose, and tax identity. This protects the owners and shareholders, as this allocates the responsibility of the business activities to the corporation itself. In the event that a lawsuit is filed, the corporation may be sued, not the individuals behind the corporation.

One of the main benefits of S Corporation taxation is that the shareholders are not required to pay any self-employment tax on their share of the profits. It is important to know, however, that the shareholders will be taxed on the salary that they pay themselves. Before the corporation can incur any profits, any owners who work as employees must be paid a reasonable salary. This salary is subject to Social Security and Medicare taxes. Once the S Corporation is making enough money that there is a profit after the payment of the salary, the shareholders do not have to pay self-employment tax on those profits. Finally, if you plan for the corporation to go public at any point, it is beneficial to start with an S Corporation to take advantage of the “flow-through” taxes. 

These are just some of the factors you should consider when choosing to form an S Corporation. Never undervalue the advice of an attorney on this, or any business matter. If you have questions or are in need of further guidance for your business, do not wait to reach out to us.



Reginald A. Rhodes, JD, LL.M. has an office in Dothan, AL and serves clients nationwide.



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