S corporations have many advantages, and tax savings are high on the list of benefits. In fact, the simplicity of the S corp tax form and favorable tax treatment is one of the primary reasons that companies make the switch to this business entity structure.
However, corporations, including S Corps, still have strict internal and external requirements that must be met. Failing to comply with these obligations can result in losing asset protection status and even a complete dissolution of the corporation. As such, knowing and understanding the compliance requirements of an S Corp when setting up a business is just as important as understanding the favorable tax treatment that S Corps receive.
S Corp Compliance Requirements
The compliance requirements for S corporations are the same as those for C corporations, with the exception of having more simplistic tax forms. Business owners must meet both external and internal requirements to maintain their company properly. These obligations are often referred to as “corporate formalities.”
There are far more internal requirements than external requirements for corporations, which can make it tempting to forgo these obligations. However, ignoring even internal formalities can ultimately undermine your corporate veil protection, so it is important to comply with both internal and external formalities.
External Corporate Formalities
- Pay your annual filing fee with the Secretary of State (when required by your state of organization).
- File state and federal tax returns as necessary, and pay estimated tax obligations as required.
- Report and pay payroll taxes and unemployment insurance as required in a timely manner.
- Register as a foreign corporation if your company does business in more than one state.
- Apply for and maintain required permits and business licenses, which may be compulsory by your state, county, or city government.
- Pay your registered agent promptly (if applicable).
Internal Corporate Formalities
- Conduct a Shareholders’ Meeting at least annually, and keep detailed minutes of the meeting.
- Hold an Officers and Directors Meeting at least once a year, and keep detailed minutes.
- Adopt corporate resolutions when major decisions in the business are made.
- Maintain a stock ledger and make changes when new stock certificates are issued. You may also need to file a Notice of Issuance of Securities (or similar document) with the Secretary of State.
- Keep a separate bank account for every operating and merchant account needed for your business.
- Establish proper accounting procedures and keep complete records of income and expenses.
- Keep a detailed mileage log for your vehicle with both business and personal use miles.
- Accurately document all loans that go in and out of the company.
- Sign all documents using this format: name, title, company name.
- Be sure to acquire and maintain adequate liability insurance for your business.
- Keep adequate cash or credit lines to meet reasonable operating expenses.
- Use letterhead, business cards, websites, etc. to advertise, which will help show the IRS that your corporation has the intent of making a profit.
Each state has its own list of requirements to establish and maintain a corporation; therefore, the above guide may not be entirely exhaustive for your particular state. Exact compliance is generally not required, but a court will determine whether the corporate veil should be pierced by considering the complete picture regarding the corporation. As a result, the more compliance boxes you can check, the better.
Taxation Considerations for S Corps
S Corporations are a “pass-through” entity, which means that, unlike a C Corp, these business entities do not have their own separate tax obligations. Instead, the tax benefits and drawbacks flow through to the individual owners and are reflected on their personal income tax returns.
When you operate an S Corp, you are both an employee and a shareholder. That means that you receive a salary or wage as an employee and you receive distributions for your portion of ownership in the company. Only your wages are subject to employment tax, which also includes contributions to Social Security, Medicare, or self-employment tax.
While avoiding the “double taxation” of a corporation is generally desirable, it may not always be the best financial decision. When you are starting a business or considering transitioning to another business structure, you should sit down and contemplate exactly what your tax situation will look like under that particular structure. Transitioning to an S corp may not always result in tax savings. It may be helpful to involve a tax professional in this type of process.
More Aspects to Consider
While the tax benefits can be appealing, you should also consider the extra costs that you will need to expend to deal with compliance. In addition, you should think about some of the limitations of S Corp ownership as well. For companies looking to attract investors or expand quickly, an S Corp may not be the right choice.
These limitations include:
- Having less than 100 shareholders
- All shareholders must be U.S. residents
- Shareholders are limited to individuals, estates, and some types of trusts (no corporations or foreign residents)
- Only one class of stock
If for some reason, you violate these requirements, your company may revert automatically to a C Corporation for three years.
Learning more about the various business structures will help you determine which choice is right for you, whether that is an S corp or something entirely different. Our video library includes hours of valuable information regarding business structures, tax savings ideas, and wealth management—and now, you can access it for free. Sign up for a free membership.