S Corporation Library

The need for compliance with government requirements only gets more important after forming a corporation or LLC. Very often the corporation or LLC was set up in the first place to help protect personal assets and provide tax-deductible benefits for owners and employees. Failure to satisfy these ongoing requirements, however, could result in the organization losing those very benefits.

Small business owners are especially at risk of stumbling into this particular pitfall. Since they are often overwhelmed with the multiple facets of their business’ day-to-day operating needs, they may not know how to avoid noncompliance and the resulting crippling or fatal business consequences. IncFile.com can help.

Corporations and LLCs have both internal and external ongoing requirements. The internal requirements must be met by the directors of the corporation or the members of the LLC, and then documented in company records. External requirements are those imposed by the state in which the LLC or corporation was formed; these often include, at a minimum, an annual (every year) or biennial (every two years) filing with the state, as well as some kind of fee.

Internal Requirements

Internal requirements are frequently overlooked, but are vitally necessary to effective decision-making and communication within the organization. A corporation has more internal requirements than an LLC; these include holding and properly documenting director and shareholder meetings, adopting and updating bylaws, issuing stock to shareholders, and recording stock transfers. While these actions are not specifically required for an LLC, it’s still a good idea to adopt an operating agreement (and keep it up to date with amendments as needed), issue membership shares, record interest transfers, and hold annual meetings.

Owners use a consolidated corporate records book to organize and maintain important corporate documents such as articles, bylaws, meeting minutes, resolutions, stock certificates, deeds, and so on. Many business owners use a Corporate Kit or LLC Kit for organizing and maintaining these vital records. Many businesses also use a metal or rubber corporate seal—the kind that leaves the company name in raised letters on a document—to signify that the document is an authorized, official transaction of the corporation. These can be obtained as part of a corporate kit or from a stationery store.

Bylaws lay out the corporation’s basic operating principles; they should be planned for and drawn up as part of the incorporation process. It is not required to file the bylaws with any government agency, but a corporation is required to have at least an initial and annual meetings, adopt bylaws, and keep minutes of the meetings, and keep these on file with the corporate records. Bylaws are important because they set down formal rules for such things as: when and how meetings can be held; notice, quorum, and voting rules for meetings; how decisions can be reached and recorded outside of meetings; basic titles and responsibilities of corporate officers; and the requirements for providing periodic (usually at least annual) information to shareholders.

In short, bylaws are the corporation’s major decision-making and operating procedures set down on paper. This can help owners refine and improve their common practices, and can also serve as a “referee” when uncertainty or disagreements arise on what the official solution is to a given situation or need. Bylaws also give your firm credibility in the eyes of shareholders, creditors, potential investors, other businesses, and even the IRS. Owners should take care, though, to make sure their bylaws do not conflict with their state’s Business Corporation Act or its equivalent.

If the board of directors is not already appointed in the articles of incorporation—a requirement in some states—the initial board’s names and addresses will need to be listed in a separate document. These directors will serve on the board until the first annual shareholders’ meeting, when a new board will be elected.

One of the new corporation’s most important tasks is to prepare minutes for the first board of directors meeting. This first meeting is where several key company actions should be approved, such as electing officers, adopting bylaws, selecting the main office or headquarters location, choosing a bank for corporate accounts, the accounting period or fiscal year, initial tax elections, and issuance of initial shares of corporate stock. Normally the groundwork and supporting research is done before the actual meeting, although the board can change or amend the minutes as prepared if they vote to do so. Any of the initial directors can prepare the minutes, but the entire board must sign them at the meeting, incorporating any amendments or changes as needed.

Thereafter, at a minimum, the corporation must hold a shareholders’ meeting and a board of directors meeting at least annually; accurate, complete minutes for both are essential, because these documents will be used as reference materials for future decisions. Remember: “If it’s not written down, it didn’t happen.”

A limited liability company, on the other hand, comes officially into being when its articles of organization are filed with the state’s LLC office. The articles contain basic organizational information about the LLC, such as its name; whether it’s managed by its members or by selected members called managers; the name and address of its members; and where its office is.

Next to its articles of organization, the most important document for an LLC is its operating agreement. This isn’t required by the state (except for New York)—but it’s a key internal document that officially records how the LLC will run. It is very much the same as a partnership agreement; except for an LLC it is called an operating agreement. It lists the members, how much each member has invested, how profits will be divided, and how much weight each member has when matters come to a vote. It may also specify requirements for meetings (notice, quorum, voting rules, etc.) and the like, but it doesn’t have to. Normally, however, the operating agreement does include state-mandated requirements.

External Requirements

External requirements usually consist of a periodic report to the state and some kind of fee. Most states require corporations and LLCs to file an annual or biennial statement or report, along with an associated filing fee of some kind. LLCs may also be liable for payroll tax, property taxes, sales and use taxes or “seller’s permits,” or business license renewals. Other state or local filings, such as business licensing or state or municipal tax registrations, may also be required. Owners will also still file their individual state and federal income tax returns.

Some states also impose a franchise tax—basically a fee paid by the company for the state’s permission to operate there. Different states use different methods to calculate the franchise tax; it may be based on revenue, or on some measure such as a corporation’s total number of authorized shares and their value.

Each state has its own deadlines for annual statements and franchise taxes. Some states determine these based on the formation anniversary of the corporation or LLC. Other states set one deadline for annual statements for all corporations and another for all LLCs. Business owners need to know how and where to research these requirements so that they can plan for them before incorporating, and then keep up with changing requirements as their business continues to operate and progress.

Copyright Notice: Guests of IncFile.com’s website may not copy, republish, or redistribute information or material from its website in any form, printed or electronic, without the express written consent of IncFile.com. Requests for use of copyrighted material from the IncFile.com website should be directed to support@incfile.com.

There are several decisions to consider when forming a business entity; it is important to be familiar with the tax ramifications of a given business entity before it is filed with the designated state agency. Forming an S Corporation is one of several options when deciding which type of business entity to form; other options include the LLC and C Corporation. There are several practical and legal concerns to take under consideration as you determine how to structure your business. You must establish whether or not your company will go public, you also need to consider the number of partners or shareholders within the company, and, perhaps most importantly, explore all the tax ramifications of each business entity. With all these considerations in mind, there are some distinct advantages to choosing the S Corporation as your business entity.

One advantage of the S Corporation is that like the LLC it receives pass through taxation. Pass through taxation simply means that federal income tax is not assessed at the entity level; profits are distributed in the form of dividends and flow through to the individual tax returns of the shareholders, and the IRS taxes the shareholders at their individual income tax rate and not at the entity or corporation level. Therefore the S Corporation, unlike the C Corporation, is not subject to double taxation. Since net losses are “passed through” as well, the individual shareholder may be able to reduce his or her tax liability by offsetting other income with any S Corporation losses. One of the most enticing advantages of the S Corporation is its ability to minimize payroll / self employment taxes which can be a significant amount of money, currently the rate is set at 15.3%. For example let’s take an S Corporation with a single shareholder, if the company was to have a net profit of $90,000.00 and the shareholder / employee assigned himself a salary of $25,000.00 he would be able to reduce payroll / self employment taxes by $9,945.00. This is because only the $25,000.00 salary portion would be classified as earned income and subject to payroll / self employment taxes, the remaining $65,000.00 would pass through as a non-qualified dividend. While taxed at the personal income tax rate of the shareholder, the $65,000.00 is exempt from the self-employment / payroll taxes.

Companies doing business as an LLC have the same advantage of pass through taxation; however a single member LLC is treated as a disregarded entity by the IRS. The business entity is disregarded as a separate entity from its owner for Federal tax purposes; essentially what this means is that the IRS classifies the single member LLC as a sole proprietorship and since all income from a sole proprietorship is treated as earned income the full $90,000.00 would be subject to the 15.3% payroll / self employment tax. For this reason, an S Corporation could be viewed as a superior entity choice for the individual owner who is looking to minimize his or her payroll and self-employment tax exposure.

A multimember LLC is treated by the IRS as a Partnership as the default status for federal tax purposes. This requires that the LLC file the Form 1065 Partnership return (informational only - the LLC does not pay federal taxes), and the net income (or loss) passes through and is accounted for on the tax returns of each individual member.

Companies doing business as S Corporation must first form a standard corporation with the state (and the default federal tax status at that point is that of a C Corporation). After the corporation is formed with the state the company must file an IRS Small Business Tax Election form 2553 stating their intention to be taxed as an S Corporation. IncFile prepares the Form 2553 and returns it to you for your signature along with your filed corporation, and after the initial shareholders have signed it can simply be faxed or mailed in to the IRS. The IRS Form 2553 must be signed and submitted to the IRS within 75 days of the date of formation of the Corporation.

For many businesspeople, the choice of “business entity” comes down to a choice between the Limited Liability Company (LLC) and S-Corporation.

While quite similar in many respects, LLC’s and S-Corporations both have advantages over one another.

For example, while LLCs and S-Corporations share the same “separate entity” status enjoyed by corporations (meaning the company is a separate entity from its owners), the profits and voting power are not necessarily allotted the same way.

An S-Corporation divides profits between its shareholders evenly. Someone with 30% of the stock would receive 30% of the profits while another with 10% of the stock would receive 10% of the profits, and so on.

This is not the case with the LLC. In an LLC, the members (akin to stockholders, although LLC’s usually issue “member units” as opposed to common stock) decide how profits should be divided. There may be someone with 10% of the “stock”, but they put in 30% of the work. This stockholder can receive more than what they have invested if the other members agree that they deserve it.

The same goes with voting power. S-Corporations follow a more traditional structure by which voting power is determined by stock ownership. An LLC can give more or less voting power to stockholders regardless of how much stock they may own.

Also, there are several other abilities an LLC has that do not apply to S-Corporations.

LLCs:

* No ownership restrictions - virtually anyone (individuals, Corporations, other LLC’s, and even foreign entities may be owners of an LLC).
* Can operate with a single member.
* Are not required to hold annual meetings.

An S-Corporation has separate ownership provisions. The S-Corporation is limited to 75 shareholders all of which are required to be US citizens. They are also required to hold shareholder and corporate meetings, which can affect record-keeping needs and continuity within a company.

LLCs sound pretty good, right?

Well (and you knew this was coming), there are some down-sides too.

For starters, S-Corporations get better deductions in regards to benefits (health insurance, etc.)

The status of the pass through income is a little different as well for the personal service principals (the principals that are employees.) It is considered “passive income” and not “earned income (like it is with an LLC.) Thus, Social Security and Medicare taxes (at this writing) are not levied.

In addition, LLC’s may have a limited shelf-life. Some states have a cap on how long they can stay in business (30 years, etc.)

In closing, you could say that S-Corporations allow for more shareholder uniformity and tax savings, while an LLC allows more free negotiations and possibilities for ownership and accountability. You can almost think of an LLC as a marriage between a classic small business (partnership / sole proprietorship) and a corporation.

While both types are separate legal entities from their owners (shareholders), only C-Corporations operate as a separately taxed entity from their owners.

This means that the shareholders, employees, owners of a C-corporation pay tax on their personal salary, while the corporate profits are taxed separately (and often at a lower rate). The downside to this is that when the after-tax profit is dispersed as dividends, it is taxed again (although tax laws do change from time to time).

S-corporations are not treated as separate taxable entities like C-Corporations. Because of this, net income is passed through the S-Corporation to the personal income tax of the owner(s).

What does this mean? It means a completely different taxing structure. C-Corporations must file and pay taxes with the IRS, separately from he income/salary/bonuses of the owners and employees. The first $50,000 of taxable corporate income is federally taxed at a rate of 15%, and the next $25,000 is taxed at 25%.

S-Corporations do not face the same taxing burden. Because the profits pass through to the shareholders, the business does not have to file taxes in the traditional way. They simply need to file a form 1120S, which is similar to the filing required for a C-corporation, but it is only an informative document; no corporate income taxes are paid to the IRS for the S-corporation. The owners pay personal income taxes as follows: Compensation (in the form of salaries, bonuses, etc.) is treated as ordinary personal income for federal taxation purposes and are subject to payroll taxes, whereas after compensation corporate net income is distributed to the shareholders in proportion to their share of company ownership and is treated as a non-qualified dividend (i.e. Such income is taxed at the personal income tax rate, but is not subject to payroll or self-employment taxes).

Both corporations are controlled by shareholders - each “share” is actually a tiny stake in the company (i.e.: a common share of stock.) These shareholders have a limited personal liability, meaning they cannot lose more than they invest. It also means that their company will always exist, unless they choose to close it (and assuming that any reporting and tax requirements are met and kept current, and the corporation otherwise stays compliant with the law).

While there are generally no citizenship or residency requirements to be a shareholder of a C-Corporation, this is not the case for an S-Corporation. United States citizens and resident aliens are generally free to own shares, non-resident aliens are barred from ownership in an S-Corporation.

While an S-Corporation can be perceived to have a better personal financial impact, they are subject to restraints that do not bind C-Corporations.

S-Corporations may not:

* Exceed 100 shareholders.
* Have shareholders who are non-resident aliens.
* Have more than one class of stock.

Have shareholders that are other corporate entities; S-Corporation shareholders must be natural persons.

C-Corporations are not subject to these restraints, giving them more room to grow and expand.

Both S and C-Corporations offer positives and negatives. While S-Corporations may have better circumstances with which to profit the principals (in most cases), C-Corporations have more flexibility, allowing them to expand beyond the scope of most S-Corporations.