Operating as an S corporation may be wise for several reasons:

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1 S Crpratin Facts S crpratins are similar t LLCs in that they prvide wners with limited liability prtectin while ffering the tax structure f a partnership. Many entrepreneurs have tw gals when chsing a structure fr their business: Prtecting their persnal assets frm business claims (limited liability) and having business prfits taxed n their individual tax returns. Nt lng ag, an S crpratin was the nly chice fr these business wners. In recent years, hwever, S crpratins have been largely replaced by limited liability cmpanies (LLCs). Still, sme businesses can benefit by rganizing as S crpratins. What Is an S Crpratin? An S crpratin is a regular crpratin that has elected "S crpratin" tax status. Frming an S crpratin lets yu enjy the limited liability f a crprate sharehlder but pay incme taxes as if yu were a sle prprietr r a partner. In a regular crpratin (als knwn as a C crpratin), the cmpany itself is taxed n business prfits. The wners pay individual incme tax nly n mney they receive frm the crpratin as salary, bnuses, r dividends. By cntrast, in an S crpratin, all business prfits "pass thrugh" t the wners, wh reprt them n their persnal tax returns (as in sle prprietrships, partnerships, and LLCs). The S crpratin itself des nt pay any incme tax, althugh an S crpratin with mre than ne wner must file an infrmatinal tax return like a partnership r LLC, t reprt each sharehlder's prtin f the crprate incme. Mst states fllw the federal pattern when taxing S crpratins: They dn't impse a crprate tax, chsing instead t tax the business's prfits n the sharehlders' persnal tax returns. Abut half a dzen states, hwever, tax an S crpratin like a regular crpratin. The tax divisin f yur state treasury department can tell yu hw S crpratins are taxed in yur state. Shuld Yu Elect S Crpratin Status? Operating as an S crpratin may be wise fr several reasns: Frming an S crpratin generally allws yu t pass business lsses thrugh t yur persnal incme tax return, where yu can use it t ffset any incme that yu (and yur spuse, if yu're married) have frm ther surces. When yu sell yur S crpratin, yur taxable gain n the sale f the business can be less than it wuld have been had yu perated the business as a regular crpratin.

2 S crpratin sharehlders are nt subject t self-emplyment taxes (active LLC wners are). These taxes, which add up t mre than 15% f yur incme, are used t pay yur Scial Security and Medicare taxes. Aside frm the benefits, S crpratins impse strict requirements. Here are the main rules: Each S crpratin sharehlder must be a U.S. citizen r resident. S crpratins may nt have mre than 100 sharehlders. S crpratin prfits and lsses may be allcated nly in prprtin t each sharehlder's interest in the business. An S crpratin sharehlder may nt deduct crprate lsses that exceed his r her "basis" in crprate stck -- which equals the amunt f the sharehlder's investment in the cmpany plus r minus a few adjustments. S crpratins may nt deduct the cst f fringe benefits prvided t emplyeesharehlders wh wn mre than 2% f the crpratin. Frtunately, a decisin t elect t be an S crpratin isn't permanent. If yur business later becmes mre prfitable and yu find there are tax advantages t being a regular crpratin, yu can drp yur S crpratin status after a certain amunt f time. Hw t Elect S Crpratin Status T create an S crpratin, yu must first create a regular crpratin by filing articles f incrpratin with yur secretary f state's ffice r yur state's crpratins divisin. Then, t be treated as an S crpratin, all sharehlders must sign and file IRS Frm LLC Basics Limited liability cmpanies cmbine the best aspects f partnerships and crpratins. A limited liability cmpany (LLC) cmbines the crpratin's prtectin frm persnal liability fr business debts and the pass-thrugh tax structure f a partnership r sle prprietrship. And, while setting up an LLC is mre difficult than creating a partnership r sle prprietrship, running ne is significantly easier than running a crpratin. Here are the main features f an LLC: Limited Persnal Liability

3 Like sharehlders f a crpratin, all LLC wners are prtected frm persnal liability fr business debts and claims. This means that if the business itself can't pay a creditr -- such as a supplier, a lender, r a landlrd -- the creditr cannt legally cme after any LLC member's huse, car, r ther persnal pssessins. Because nly LLC assets are used t pay ff business debts, LLC wners stand t lse nly the mney that they've invested in the LLC. This feature is ften called "limited liability." Exceptins t Limited Liability While LLC wners enjy limited persnal liability fr many f their business transactins, this prtectin is nt abslute. This drawback is nt unique t LLCs, hwever -- the same exceptins apply t crpratins. An LLC wner can be held persnally liable if he r she: persnally and directly injures smene persnally guarantees a bank lan r a business debt n which the LLC defaults fails t depsit taxes withheld frm emplyees' wages intentinally des smething fraudulent, illegal, r reckless that causes harm t the cmpany r t smene else, r treats the LLC as an extensin f his r her persnal affairs, rather than as a separate legal entity. This last exceptin is the mst imprtant. If wners dn't treat the LLC as a separate business, a curt might say that the LLC desn't really exist and find that its wners are really ding business as individuals, wh are persnally liable fr their acts. T keep this frm happening, make sure yu and yur c-wners: Act fairly and legally. D nt cnceal r misrepresent material facts r the state f yur finances t vendrs, creditrs, r ther utsiders. Fund yur LLC adequately. Invest enugh cash int the business s that yur LLC can meet freseeable expenses and liabilities. Keep LLC and persnal business separate. Get a federal emplyer identificatin number, pen up a business-nly checking accunt, and keep yur persnal finances ut f yur LLC accunting bks. Create an perating agreement. Having a frmal written perating agreement lends credibility t yur LLC's separate existence.

4 Business Insurance A gd liability insurance plicy can shield yur persnal assets when limited liability prtectin des nt. Fr instance, if yu are a massage therapist and yu accidentally injure a client's back, yur liability insurance plicy shuld cver yu. Insurance can als prtect yur persnal assets in the event that yur limited liability status is ignred by a curt. In additin t prtecting yur persnal assets in such situatins, insurance can prtect yur crprate assets frm lawsuits and claims. But yur LLC wn't be prtected if it desn't pay its bills: cmmercial insurance usually des nt prtect persnal r crprate assets frm unpaid business debts, whether r nt they're persnally guaranteed. LLC Taxes Unlike a crpratin, an LLC is nt cnsidered separate frm its wners fr tax purpses. Instead, it is what the IRS calls a "pass-thrugh entity," like a partnership r sle prprietrship. This means that business incme passes thrugh the business t the LLC members, wh reprt their share f prfits -- r lsses -- n their individual incme tax returns. Each LLC member must make quarterly estimated tax payments t the IRS. While an LLC itself desn't pay taxes, c-wned LLCs must file Frm 1065, an infrmatinal return, with the IRS each year. This frm, the same ne that a partnership files, sets ut each LLC member's share f the LLC's prfits (r lsses), which the IRS reviews t make sure LLC members are crrectly reprting their incme. LLC Management The wners f mst small LLCs participate equally in the management f their business. This arrangement is called "member management." There is an alternative management structure -- smewhat awkwardly called "manager management" -- in which yu designate ne r mre wners (r even an utsider) t take respnsibility fr managing the LLC. The nnmanaging wners (smetimes family members wh have invested in the cmpany) simply sit back and share in LLC prfits. In a manager-managed LLC, nly the named managers get t vte n management decisins and act as agents f the LLC. Chsing manager management smetimes makes sense, but it might require yu t deal with state and federal laws regulating the sale f securities. Frming an LLC T create an LLC, yu file "articles f rganizatin" (in sme states called a "certificate f rganizatin" r "certificate f frmatin") with the LLC divisin f yur state

5 gvernment. This ffice is ften in the same department as the crpratins divisin, which is usually part f the secretary f state's ffice. Filing fees range frm abut $100 t $800. Yu can nw frm an LLC with just ne persn in every state. Many states supply a blank ne-page frm fr the articles f rganizatin, n which yu need nly specify a few basic details abut yur LLC, such as its name and address, and cntact infrmatin fr a persn invlved with the LLC (usually called a "registered agent") wh will receive legal papers n its behalf. Sme states als require yu t list the names and addresses f the LLC members. In additin t filing articles f rganizatin, yu must create a written LLC perating agreement. While yu dn't have t file yur perating agreement with the state, it's a crucial dcument because it sets ut the LLC members' rights and respnsibilities, their percentage interests in the business, and their share f the prfits. Ending an LLC Crpratin Basics Under the laws f many states, unless yur perating agreement says therwise, when ne member wants t leave the LLC, the cmpany disslves. In that case, the LLC members must fulfill any remaining business bligatins, pay ff all debts, divide any assets and prfits amng themselves, and then decide whether they want t start a new LLC t cntinue the business with the remaining members. Yur LLC perating agreement can prevent this kind f abrupt ending t yur business by including "buy-sell," r buyut, prvisins, which set up guidelines fr what will happen when ne member retires, dies, becmes disabled, r leaves the LLC t pursue ther interests. Frming a crpratin limits yur persnal liability fr business debts, but running ne takes wrk. Mst peple have heard that frming a crpratin prvides "limited liability" -- that is, it limits yur persnal liability fr business debts. What yu may nt knw is that there's mre t creating and running a crpratin than filing a few papers. Yu'll need t keep gd recrds t handle the mre cmplicated crprate tax return and, in rder t retain yur limited liability, yu must fllw crprate frmalities invlving decisin making and recrd keeping. In shrt, yu've gt t be rganized. Limited Persnal Liability One f the main advantages f incrprating is that the wners' persnal assets are prtected frm creditrs f the crpratin. Fr instance, if a curt judgment is entered against yur crpratin saying that it wes a creditr $100,000, yu can't be frced t use persnal assets, such as yur huse, t pay the debt. Because nly

6 crprate assets need be used t pay business debts, yu stand t lse nly the mney that yu've invested in the crpratin. Exceptins t Limited Liability There are sme circumstances in which limited liability will nt prtect an wner's persnal assets. An wner f a crpratin can be held persnally liable if he r she: persnally and directly injures smene persnally guarantees a bank lan r a business debt n which the crpratin defaults fails t depsit taxes withheld frm emplyees' wages des smething intentinally fraudulent r illegal that causes harm t the cmpany r t smene else, r treats the crpratin as an extensin f his r her persnal affairs, rather than as a separate legal entity. This last exceptin is the mst imprtant. In sme circumstances, curts can rule that a crpratin desn't really exist and that its wners shuld nt be shielded frm persnal liability fr their acts. This might happen if yu fail t fllw rutine crprate frmalities such as: adequately investing mney in ("capitalizing") the crpratin frmally issuing stck t the initial sharehlders regularly hlding meetings f directrs and sharehlders, r keeping business recrds and transactins separate frm thse f the wners. Liability Insurance Incrprating shuld never take the place f gd business insurance. Even thugh frming a crpratin prtects yur persnal assets, yu shuld use insurance t guard yur crprate assets frm lawsuits and claims. A slid liability insurance plicy can prtect yu against many f the risks f ding business. Fr instance, if yu perate a clthing stre, gd business insurance shuld adequately cver the bill if smene slips and falls in yur stre. Als, insurance can prtect yu where the limited liability feature will nt. Fr example, if yu persnally injure smene while ding business fr the crpratin, say by causing a car accident, liability insurance will usually cver the accident s that yu wn't have t use either crprate r persnal assets t pay the bill.

7 Hwever, insurance wn't help if yur crpratin desn't pay the bills: cmmercial insurance usually des nt prtect persnal r crprate assets frm unpaid business debts, whether r nt they're persnally guaranteed. Paying Crprate Incme Tax If an wner f a crpratin wrks fr the crpratin, that wner is paid a salary, and pssibly bnuses, like any ther emplyee. The wner pays taxes n this incme just like regular emplyees, reprting and paying the tax n his r her persnal tax return. The crpratin pays taxes n whatever prfits are left in the businesses after paying ut all salaries, bnuses, verhead, and ther expenses. T d this, the crpratin files its wn tax return, Frm 1120, with the IRS and pays taxes at a special crprate tax rate. Alternatively, crprate sharehlders can elect what's called "S crpratin" status by filing Frm 2553 with the IRS. This means that the crpratin will be treated like a partnership (r LLC) fr tax purpses, with business prfits and lsses "passing thrugh" the crpratin t be reprted n the wners' individual tax returns. Frming a Crpratin T frm a crpratin, yu must file "articles f incrpratin" with the crpratins divisin (usually part f the secretary f state's ffice) f yur state gvernment. Filing fees are typically $100 r s. Fr mst small crpratins, articles f incrpratin are relatively shrt and easy t prepare. Mst states prvide a simple frm fr yu t fill ut, which usually asks fr little mre than the name f yur crpratin, its address, and the cntact infrmatin fr ne persn invlved with the crpratin (ften called a "registered agent"). Sme states als require yu t list the names f the directrs f yur crpratin. In additin t filing articles f incrpratin, yu must create "crprate bylaws." While bylaws d nt have t be filed with the state, they are imprtant because they set ut the basic rules that gvern the nging frmalities and decisins f crprate life, such as hw and when t hld regular and special meetings f directrs and sharehlders and the number f vtes that are necessary t apprve crprate decisins. Finally, yu must issue stck certificates t the initial wners (sharehlders) f the crpratin and recrd wh wns the wnership interests (shares r stck) in the business.

8 Retaining Crprate Status Crpratins and their wners must bserve certain frmalities t retain the crpratin's status as a separate entity. Specifically, crpratins must: hld annual sharehlders' and directrs' meetings keep minutes f sharehlders' and directrs' majr decisins make sure that crprate fficers and directrs sign dcuments in the name f the crpratin maintain separate bank accunts frm their wners keep detailed financial recrds, and file a separate crprate incme tax return Prs and Cns: Business Frm and Taxatin Type PROS CONS "S" Crpratin "C" Crpratin S Crpratin may elect t be treated as a partnership fr federal tax purpses with sharehlders reprting their share f the crpratin's separately listed items f incme, deductins, lss, and credit n their persnal tax returns. Sharehlders have persnal limited liability. Sharehlders have limited persnal liability. Health insurance premiums and grup life insurance up t $50,000 in benefits are fully deductible by the crpratin and nt taxable t the emplyees. S Crpratin may nt have mre than seventy-five sharehlders. Sharehlders and thse wning 5 percent r mre in stck have limited emplyee benefits. Duble taxatin-the crpratin pays taxes n its incme and the sharehlder pays taxes n dividends. Sharehlders cannt deduct the lsses f the crpratin. Limited Liability Cmpany The crprate tax rate desn't g as high as the individual rate (what a sle prprietr r partner wuld pay n an individual tax return). Persnal limited liability f members. N duble taxatin. May have mre than seventy-five members. Under IRS "check-the-bx" rules a limited liability cmpany may chse whether t be taxed like a partnership r a crpratin. Active members are subject t selfemplyment tax fr Scial Security and Medicare. Limited liability cmpanies are a relatively new business frm and the laws are still evlving.