Filing as an S Corporation
When you’re forming a new venture, choosing the type of legal entity through which you’ll conduct business can have a major impact on the future of your company. Many small businesses end up choosing between forming an LLC and an S Corporation. Each comes with its own advantages and disadvantages regarding liability of owners and shareholders, taxation, and complexity of management. Below, you’ll find a brief primer on S Corporations, and in a future post, we’ll explain LLCs. Before making a decision, contact an experienced California business law attorney to ensure that you make the right choice.
S Corporation basics
The name “S Corporation” or “S Corp” indicates a corporation that has chosen to be taxed under federal subchapter S. This allows for “pass-through” federal taxation of corporate profits, meaning that each shareholder reports earnings and pays taxes through their individual federal income tax return only. This is in contrast to the taxation of a traditional C corporation, which would be forced to pay federal taxes directly while the shareholders would also be taxed on any profits they received.
Filing as an S Corp
In California, S Corps must file articles of incorporation with the California Secretary of State, and will be subjected to a 1.5% tax on their net income. In order to elect S Corp tax status, the corporation must file election documents within 2 months and 15 days from the date of formation in order to have S Corp status for that first tax year.
Not any business can register as an S Corporation. In order to qualify as an S Corp, there is a limit of 100 shareholders, who must all be either individuals residing in the US, qualified estates, or trusts. In other words, another corporation can’t hold shares of an S Corp, nor can someone who is not a legal resident of the US (either a green card holder or someone who passes the “substantial presence” test).
S Corp management
Owners of S Corps are considered shareholders, and those shareholders must conduct regular meetings documented by corporate minutes. S Corps are managed by boards of directors. The board is charged with appointing the entity’s officers, namely the president, secretary, and treasurer. Officers will be considered agents of the corporation, able to make decisions on behalf of the company that are legally binding, and are charged with the day-to-day management of the company. Shareholders, the owners of the company, may vote on a board of directors, but they don’t otherwise participate in management of the company. That said, many S Corps consist of only a single individual who is an officer, director, and shareholder.
Liability of S Corps
Shareholders of an S Corp should receive stock certificates to signify their ownership stake in the corporation. Any changes in ownership must be carefully documented. Shareholders of an S Corp are typically shielded from personal liability for debts of the company. That said, if the corporation is not properly formed and those formalities are not closely observed, shareholders could be vulnerable to “veil-piercing” actions. “Piercing the corporate veil” allows a person or entity who is owed money by the S Corp to make its shareholders individually liable for these debts.
If you are in the process of forming a business in California and need help selecting the structure that will offer the greatest tax advantages and liability protections possible, contact a San Diego business law attorney at Esprit Law for a consultation, at 619-876-0503.