The Reasons Why Companies Are S-Corps: Major Advantages (2024)

During this article, we will seek to discover just what the advantages of being an S Corp are. The benefits of an s-corp are tangible and ones to consider if you are not one already. If you are, then it might be useful to remind yourself just why you are. 

Key Factors To Consider: 

• An S Corp  (S Corporation) is a type of legal business structure. Generally, it is common among small businesses. Other than that, small businesses also take up LLC (Limited Liability Company) as a legal structure. 
• If your S Corp has up to 100 shareholders, you will have the benefit of incorporating your business. Furthermore, you can also get a taxation option as a partnership. 
• By structuring your business as an S-Corp, you do not need to pay corporate taxes. This is called becoming pass-through entities. Also, you will have Limited Liability protection for your business. 
• S-Corp shareholders include – individuals, specific estates and trusts, and a select few tax-exempt organizations.

Defining An S Corp 

To better understand the advantages of an S Corp it may prove useful to first define exactly what one is. 

A company will be classified as an S-corporation for United States federal income tax. It will mean that it is a firmly held company that makes valid elections to be charged under what is known as subchapter S concerning Chapter 1 of the IRS (Internal Revenue Code). 

S corporations have unique tax advantages and this makes them a popular choice for a wide range of small businesses. Put simply, an S-corp is a tax designation that allows a company’s profits to pass through to the owners’ personal tax returns.

For this reason, both corporations and limited liability companies (LLCs) can choose to be taxed as an S-corp. 

Basically, Subchapter S of the Internal Revenue Code states that an S-Corp is eligible to pass business income, deductions, losses, and direct credits to shareholders.

Hence, they do not need to pay any federal corporate tax in these areas. Hence, S-Corps are also known as pass-through entities.  

As a result, it gets special tax benefits under the Tax Cuts and Jobs Act 2017. However, on a corporate level, an S-Corp is liable to pay corporate-level taxes on certain gains and passive income. 

Related: LLC Vs S Corporation: Definition, Differences, Importance, And More

Major Features Of S Corporations

Despite its tax status, an S Corp is a for-profit company, and it has incorporation under the state corporation laws, as the latter governs the business operations.

The following are some of the formalities and internal practices that an S-Corp needs to follow: 

• It needs to have a Board of Directors (BoD) 

• There must be corporate bylaws in writing. 

• It must conduct shareholders’ meetings from time to time. 

• It must also record the meetings that are significant. 

Furthermore, S-Corps have the benefit of passing income directly to shareholders without paying taxes for the same. 

The Reasons Why Companies Are S-Corps

It is good to know that there are so many benefits of S-corps, and the option is still possible for the one-person business too.

We should note that where there are employees, payroll will need to take place to pay them and that any shareholders will be considered as employees.

Obviously, there are many reasons why companies are s corps and the primary ones are listed below.

1. Asset Protection As An S-Corp

Asset protection is one of the main advantages of a company being classified as an S corp for tax purposes. This means that its owners are provided with limited liability protection whatever their tax status is.

Limited liability protection will mean that the company’s owners will have personal assets protected from creditors who will look to make a claim upon them in the event of the company running out of money to pay them.

It is a protection from litigation and business contracts affecting personal wealth. Furthermore, many experts opinionate that, as a company owner, you will have peace of mind if you structure your business as an S-Corp. 

In legal terms, forming an S-corp will create a legal separation between a business and its owners. It then allows for business and personal assets to be kept completely separate. This makes for easier accounting apart from the asset protection mentioned. 

2. Transfers

S-corps make it easier for businesses to transfer business interests. This will be because business and personal interests are not all mixed as one.

We need that separation of personal assets and companies for simplicity’s sake. It is then also easier to see the financial position of our business in terms of budgeting. 

3. Tax Savings For S-Corps

Apart from protecting assets, those companies that are S-corps can benefit from tax savings. For example, federal status allows an S-Corp’s shareholders to avoid, in effect, double taxation on corporate income. 

Hence, if you register as an S-Corp, you will not need to pay federal taxes at the entity level. This also helps you to save money on corporate taxes. Hence, this will be a lot of help to your company during its early years. 

4. Saving Your Personal Income Tax

As a business owner, once you register your business as an S-Corp, you can lower your personal income tax tab. Here, S-Corps allows you to characterize the money that you receive from the business as salary or dividends. Hence, you can lower your liability for self-employment tax. 

If your business has the S-Corp status, it will generate deductions for employee wages and other business expenses. Furthermore, as already explained, there are certain tax benefits for pass-through entities like S-Corps. 

5. Corporate Dividends

An employee can be a shareholder of an S-Corp, who can both earn salaries and receive corporate dividends. These can be free of taxation if the distribution does not exceed the stock basis of the shareholder.

However, if it does exceed, the employee needs to pay taxes on the excess gains, which is a lower tax rate than the ordinary income of the employee. 

Any Restrictions On Number Of Owners? 

The good news about forming an S-corp is that it can be owned by just one person. So, there is no reason not to consider it as a sole trader.

It offers the kind of protection you would not normally have when your house and car could ordinarily be taken off you in the event of liquidation. We do not want to think about it, but we need to allow it. Our families will be glad that we did. 

An S-corp is essentially a pass-through entity. This means that income and losses will pass through the corporation and to the owner’s personal tax returns. Many smaller businesses will use S-corps because of their benefits.

Thinking about the above, something like 75% of all S-corps will be owned by only one person. The owner will then have complete control over what salary they take. 

Once salaries have been paid, the remaining business profits will be passed to shareholders through distributions. 

The Final Thoughts

There is no doubt that the protection of personal assets is a major draw to a business owner forming an S-corp, as opposed to another kind of entity. Business owners could otherwise be left with nothing should a business fail.

This can be avoided with S-corps that offer protection for those running businesses in environments that are competitive and where absolutely nothing is certain in terms of survival. 

Read Also: