What is an S Corporation?
An S corporation is treated by the federal tax system as a pass-through entity in the eyes of the IRS. To achieve this, your business must file Articles of Incorporation with the Secretary of State. Kentucky corporations are also required to file one copy of their Articles of Incorporation in the same county where the registered office is located.
Your company will then issue stock and the business will be governed as a corporation. The shareholders (those holding your stock) are the owners, but are protected from personal liability from the actions of the corporation. For instance, a shareholder’s personal property, bank accounts and other assets cannot be seized to pay off the corporation’s liabilities.
Income and losses are passed on to the shareholders. Each shareholder is responsible for the income or loss received by the corporation, on their own individual tax return. The S corporation eliminates double-taxation – once on the corporate level and once on the individual level, which happens with a regular corporation.
Advantages of an S Corporation
- Credibility – An S corporation has made a formal commitment to the business, which may appear more credible to customers, employees, partners, distributors, vendors.
- Protection of Assets – Shareholders are more protected than in other business structures (like a sole proprietor, a DBA, general partnerships or other corporation types) because their personal assets are protected from obligation to pay business debts.
- Better Characterization of Income for Shareholders – Tax benefits include the ability of shareholders to be employees of the business, to draw a salary, and receive dividends. This type of corporation can be set up to help owner-operators reduce self-employment taxes, while enjoying deductions for business expenses for the business.
- Easier to Transition – S corporations can be transferred more easily than partnerships or LLCs.
- Elimination of Double-Taxation – An S corporation isn’t taxed by the federal government on the corporate level.
Disadvantages of an S Corporation
- Allocation of Income and Loss is Less Flexible – Allocation cannot be set in an operating agreement. Instead, allocation is dictated by stock ownership and cannot be easily allocated to specific shareholders, since all stocks of an S corp are a single class of stock. The number of shareholders is also limited — to 100 — and no stocks can be owned by foreign entities. Certain types of trusts are prohibited from stock ownership, as are some other entities.
- The IRS Watches Closer – S corporations tend to be more closely scrutinized by the IRS, to determine if distributions of dividends and salaries are properly characterized. Incorrect classifications of these can lead to the loss of the compensation paid deduction and a higher employment tax liability. Mistakes in filing requirements, stock ownership and election, consent and notification can nullify the S corporation’s legal status as a corporation.
- Expenses for Corporate Formation and Ongoing Maintenance – You must secure a registered agent in Kentucky for the company, pay the registered agent’s fees, and pay the cost to properly file the Articles of Incorporation. There may also be annual report and other tax fees.
If you have questions, call us. We can sit down to determine if a Kentucky S corporation is the best option for your business.