Who Can Be an Owner?
An S-Corporation (S-Corp) is a type of business entity in the United States that offers certain tax benefits, like a partnership or LLC, while maintaining some of the limited liability features of a traditional corporation (C-Corp). However, S-Corps have specific ownership requirements to maintain their favorable tax treatment.
- Individuals: Generally, U.S. citizens and resident aliens are eligible to be shareholders of an S-Corp.
- Estates and Trusts: Certain types of trusts and estates may qualify as shareholders.
- Qualified Subchapter S Trusts (QSSTs): These trusts are designed to hold S-Corp stock for the benefit of a single individual. They have specific requirements to maintain their status.
- Certain Tax-Exempt Organizations: Some tax-exempt organizations, like 501(c)(3) organizations, can own S-Corp shares under certain conditions.
- Certain Family Members: Under certain conditions, certain family members can collectively own shares in a family-owned S-Corp.
It’s important to note that partnerships, corporations, non-resident aliens, and most types of trusts are generally not eligible to be shareholders of an S-Corp.
So, Why Does Ownership Matter?
Ownership matters for S-Corps because maintaining eligibility for S-Corp status has significant tax implications. S-Corps are pass-through entities, meaning they don’t pay federal income taxes at the corporate level. Instead, the income and losses of the S-Corp “pass through” to the shareholders’ tax returns. This can lead to potential tax savings, as compared to C-Corps that are subject to double taxation. For more information on this, read our blog about double taxation. https://www.whittakercpas.com/what-is-double-taxation-and-how-does-it-apply-to-c-corporations/
However, to retain these tax benefits, an S-Corp must meet specific IRS requirements, including the limitation on the number and type of shareholders. If an S-Corp violates these requirements, it may lose its S-Corp status and be subject to different tax rules.
Different Classes of Stock
S-Corps can have only one class of stock. This means that all shares have the same rights and privileges, including distribution rights. However, having stock with voting rights along with stock that is nonvoting doesn’t create a second class of stock. This restriction is in place to prevent the creation of complex ownership structures that could potentially benefit certain shareholders over others, which is a requirement to maintain the pass-through tax treatment.
LLC vs. S-Corp.
Choosing between an LLC and an S-Corp depends on the specific needs and circumstances of your business. To find out about the differences, read our blog that discusses different entity types. Here are some of the main differences.
- Ownership Flexibility: LLCs offer more flexibility in terms of ownership and management structure compared to S-Corps, which have ownership restrictions.
- Taxation: Both LLCs and S-Corps offer pass-through taxation, but S-Corps have more strict limitations on who can be shareholders.
- Self-Employment Taxes: S-Corp owners can potentially save on self-employment taxes by splitting income between salaries (subject to payroll taxes) and distributions (not subject to payroll taxes). LLC owners typically pay self-employment taxes on all profits.
- Complexity and Formalities: S-Corps often have more formalities and administrative requirements than LLCs.
- Investor Attraction: If you plan to attract outside investors or issue different classes of stock, an LLC might be more suitable.
- Foreign Ownership: LLCs can have non-resident alien owners, while S-Corps generally cannot.
If you have any questions about what this means for your company then reach out to us today. Click the link below to get started with our process and take your first step towards your new success.