Sub-Chapter S Corporation Quick Fact Sheet and Manual presented by --NationalLienLaw.com Questions: Give us a call. (800) 995-9434 What is it? Generally, it is a corporation that acts like a sole proprietorship or general partnership, but at the same time protects the owners from personal liability. It is beneficial for tax purposes because profits are not paid by the corporation but pass through to the shareholders who annually report this as income on their individual tax returns (Schedule K-1 on 1040). Because it is only taxed once at the personal level, there is no double taxation--in other words no taxing once at the corporate level and again at the personal level. Loss deductions and tax credits also pass through. Since it is a corporation, legally speaking it is a separate legal entity from the owners. When decisions are made or actions taken, you as a director or officer are acting on behalf of the corporation. You act like any other business owner except when you sign a contract, it would state: ABC Company, Inc., by its President Joan Smith. As an owner, you are now called a shareholder. Why is it called Sub-S? This name has stuck because it is a chapter of the Internal Revenue Code (Section 1361 to 1379). Specifically, it is Sub Chapter S as contained in section 1 of that Code. How does it differ from a C corporation? There are only two types of corporations: S and C. If you do not elect S status, you are automatically a C corporation. The C acts pretty much the same as the S, except the corporation is taxed first at that level and then profit to the shareholders is taxed at their level. In other words, there can be double taxation as to dividends (net profits given to a shareholder in proportion to their share interest). The C corporation would pay tax first, and if there is a dividend, the shareholders would pay at their level. This is exactly what happens to major corporations. For example, General Motors pays its taxes at the corporate level and if you are a shareholder, your dividend check is paid as income at your level. For this reason, a small business operating as a C is careful about making dividends. The C corporation is typically used if you plan to put profits back into the business each year, as opposed to distributing to shareholders. Shareholders receive their salary and benefits, but everything else is plowed back in.
Example: Frank and Joan are starting an insurance agency. This is not cheap, and they plan to be paying some pretty heavy franchise fees, office set-up, advertising, and employee costs, with the real value in their book of business consisting of yearly commissions received from insureds. They are perfectly content to receive just commissions and have their healthcare paid for. Everything else will go back into the business. They are perfect for the C corporation. The vast majority of people prefer the S format. They will certainly put money back into the business, but they can t really survive without receiving both a salary and distributions each year. How do you become an S corporation? Easy. Within 45 days of incorporating, you fill out and fax to an IRA service center a simple form 2553 (filled out for you in our Packets). There are no fees and it is automatically accepted by the IRS. How Does the IRS treat an S corporation? As stated above, the IRS does not tax the corporation itself. Profits and losses end up being handled by the individual shareholders on their personal 1040 returns. Thus, payments to the shareholders by the corporation at that level are distributed tax free. In summary, income is taxed only once at the shareholder level. Do incorporate at the state or federal level? You form the corporation at the state level with your Secretary of State. Do all states acknowledge it? Yes. Who is eligible? You must be a U.S. citizen or a permanent resident (green card). You can also act under your living trust. A partnership or another corporation cannot be a shareholder. It must be an American corporation; foreign corporations are excluded. But there is one exception. In 2008 the IRS issued Private Letter Rulings 200816002, 200816003, and 200816004 stating an S corporation will not lose its status if it has a shareholder that is a single-member LLC, provided that the LLC is a "disregarded entity" for tax purposes (wishing to be treated as a sole proprietorship and has not elected corporate tax treatment) and is owned by an individual. Can every business be an S corporation? Just about. Exclusions are banks, thrifts, insurance companies (insurance agents and brokers are OK), and domestic international sales corporations (act as brokers who help an American company export their goods).
How many shareholders? May not exceed 100. A husband and wife count as one. What kinds of stock? Only one class of stock is allowed, which in almost all cases is common voting stock. Note that preferred stock usually does not have voting rights and if the business goes under, including bankruptcy, it usually gets first dibs on whatever assets are left. So, you cannot have both common and preferred shares. Do we pay tax if profits are withheld? Yes. If the corporation makes a profit and there is still money left over in its bank account after paying salaries, expenses, and fringe benefits, that retained money is still considered income to the shareholders who report and pay taxes on their 1040. But that rarely causes a problem. If there is money left over, it is usually spent on the business or distributed to the shareholders. Most people do not mind paying taxes on profits that are put to productive use or which can be used for personal expenses. And, in this economy, few businesses horde money in their business accounts--unused. Notarized or certified paperwork? Not with the Secretary of State, but may be required for others. Some government agencies and other sources insist on receiving certified copies of your corporate papers, but if this occurs, you can always receive them for a fee from the Secretary of State s office later. In most cases, a bank will require certified copies of your Articles of Incorporation to open a business bank account. Corporate name: Do not use Bank or Trust without special permission. The business name should be followed by any of the following: Corporation, Corp., Incorporated, Inc., Limited, Ltd., Company, or Co. It is best practice to stay away from the phrase: ABC. and Company (use of and immediately before Company may not be allowed). On the other hand, ABC Company or ABC Co. is sufficient. Obviously, choose a name that is not confusingly or deceptively similar to one already registered with the state. Corporate purpose stated in articles? Most states only require a general statement or any lawful business which may be conducted in this state. Directors: a) Number. Any number. You can be a one person corporation. Recommendation: To eliminate later amending the Articles, put in more than originally planned. For example, if you have three directors presently, state: authorized number 5.
b) Residency. Directors do not have to be residents (live in the state) of the state of incorporation. Note how this differs from a resident agent. in the articles. c) Names Listed? Most states do not require listing the names of directors d) Age Requirements? Anyone over age 18. Officers: a) Number. One person may hold all offices (president, vice president, treasurer, and Secretary). b) Residency. Officers do not have to be residents (live in the state) of the state of incorporation. the articles. c) Names Listed? Most states do not require listing the names of officers in d) Age Requirements? Anyone over age 18. Registered agent: This is the person who resides in the state of incorporation and who can receive legal papers if you are sued or correspondence as to tax matters. All sates require an agent. The agent must be an individual with a permanent residence address in the state or another business entity that is registered in the state. No post office boxes are allowed (except for rural routes). The corporation cannot be its own registered agent. On the other hand you can designate any of the individual shareholders, officers, or directors if they have a permanent residence in the state. No. of authorized shares: In the Articles of Incorporation, many states require stating how many are initially authorized. Make sure you pick a large enough number so shares can be issued in the future: to other persons who may wish to join the organization or for investors (for example 10,000). That way you can issue 5,000 now so you have a reserve. Initial capital cash requirements: None in most states. But be careful. If you thinly capitalized the corporation with little or no money or property, an enterprising attorney may pierce the corporate veil and seek a judgment against your personal assets because of lack of capitalization. How much is enough? More the better, but try to have at least $5,000 to $10,000 initially.
Publishing requirements? None. Exception: Arizona (published once a week for three weeks); Nebraska (three times); Pennsylvania (two times). EIN: A corporation is required to secure a Federal EIN or tax ID number from the IRS. This is also commonly required to open a bank account, set up benefit plans, file tax returns, and open up credit accounts. We do this for you. Or you can do-it-yourself online: www.irs.gov>apply for an Employer Identification No. Online (SS-4 Form). FUTURE PAPERS TO FILE Once you file your initial corporate documents, you will receive a charter from the State which lasts indefinitely. Unlike a sole proprietorship, partnership, LLC, or professional business entity, the death of an owner, shareholder, officer, or director (even with a one person entity) does not terminate the business entity. One of the benefits of a corporation is that it is durable by nature and has perpetual existence. Annual reports to file? Yes. Every year you must file an annual report which gives an update of your corporate information. The fees are modest (average is $25). There are some rather substantial penalties for late filing, including the suspension of your charter and penalty fees for reinstatement. When are other filings needed? Normally, you are not required to file additional paperwork, but there are exceptions for material changes to the corporation, such as (along with modest fees): Change of name of registered or statutory agent (the person who is named for service of process, for example when you are sued, this person is served the papers). Change of address of the registered or statutory agent. Change of corporate registered address (when you change your main office or principal place of business). Rarely required because the bylaws allow the directors to change the main office address without amending the Articles. Foreign corporation registrations (typically when you have opened an office in another state you register with that Secretary of State as a foreign corporation).
Amending the Articles of Incorporation. Since the Articles state very little about your corporation, it is rare to file amendments. Usually, the man reasons are: change of corporate name, corporate address, type or classification of shares, increase or decrease in the number of authorized directors, and increase or decrease in the number of authorized shares, if so stated in the Articles (for example, adding more shares when additional shareholders come aboard, redemption, etc.). Correcting misstatements in the Articles Dissolving the corporation Consolidations or mergers Changing status from one entity to another (for example from a limited partnership to a corporation) Reinstatement after forfeiture due to nonpayment of corporate tax or fees There are standard secretary of state forms for all these purposes on their websites. To find them, simply do a Google search. Example: Georgia Secretary of State. WHAT IS THE BEST STATE FOR INCORPORATION? There is a lot of enticing talk about states having beneficial corporate laws it is as if they are handing you a platter with lower taxes, less paperwork, liberal requirements, and sheltering officers, directors, and shareholders from liability. Most of this is legal folklore and simply not true. In the vast majority of cases, you should incorporate in the state of the main office and where you conduct operations. There is a misconception that if you incorporate in a tax friendly state, you can eliminate taxes and only pay and file in that one state. This is simply not the case. You still have to file and pay taxes in the state(s) in which you operate. For example, assume you have one store and office in Florida but incorporate in Nevada to save taxes. You have to file papers, register and pay a fee for a Nevada in-state registered agent, and file reports in Nevada. Then you have to file papers, pay a fee, and register as a foreign corporation in your home state! You have accomplished nothing. And, since the majority of operations are in Florida, you pay income taxes in that State. Alternatively, if you performed half of your operations in Florida, you would pay 50% of the tax there. Did you really think the state of Florida would allow you to get away with paying no state income taxes? Further, regardless of the state of incorporation, you will still have to pay Federal taxes, if any.
One reason it is beneficial to incorporate in such a tax haven state is if you are a multistate corporation and are planning to register in a number of states anyway. But, what if you have an Internet business in your home with no real physical presence in any state (no warehouse, factory, office building, or store)? Some people take a gamble and incorporate in, for example in Nevada, Wyoming, Delaware, or Virginia and take the chance that Florida will never figure out what s going on and tax you. This may very well be the case since some states do not exchange information with the IRS or report the location of offices outside the incorporating state. Your choice, your risk. On the other hand, putting aside fees and taxes, there are benefits of incorporating in Nevada or Delaware from a liability standpoint. Both have special business courts with judges experienced in business matters and are corporate friendly. They are known to expedite cases and push for quick settlements. State statutes are liberal in allowing provisions in bylaws that officers and directors are not liable to the shareholders unless there is active fraud or an injustice. And, officers and directors can be indemnified (attorneys fees, costs, and judgments paid for by the corporation if there is a judgment against you). Bottom line: incorporating in Nevada or Delaware is great if your main thrust is to limit liability or have a more business friendly state. But if you are looking to save money on fees and taxes and much of your operations are out of state, it doesn t make much sense.