A sub S corp is simply a small C corporation that meets certain requirements and has made the election to be taxed as a pass- through entity under Subchapter S of the Internal Revenue Code. If you find that the structure would be beneficial to your company, you can elect to be taxed as an S corp by a unanimous vote of your company's owners and filing IRS Form 2553.
Limited Liability Benefits
As a type of corporation, an S corp has limited liability for its shareholders. Limited liability effectively puts a barrier between the company and the personal assets of the shareholders so that the personal assets can't be taken by creditors of the S corp. If you operate your business as a sole proprietor, partnership or other unincorporated entity form, and someone sues your company, your personal property can be taken to pay the judgment. With an S corp, generally you can only lose what you've put into the company.
Pass-through Tax Treatment
The pass-through tax treatment can be a big money saver for S-corp owners. Usually, a corporation has to pay the corporate income tax on its profits. Then, when it distributes those profits as dividends, the shareholders have to pay taxes on the payouts. With an S corp, the company's profits go straight to the shareholders' personal tax returns, thereby avoiding double taxation. In addition, if you have multiple streams of income, your S corp losses can be used to offset some of your other income.
Estate Planning Effects
Using an S corp for your business can help you more effectively transfer it to your heirs after your death. First, as a type of corporation, an S corp exists in perpetuity, so it will carry on after your death, even if you're the only shareholder. Also, since you can issue shares of the S corp, you can begin to transfer those shares to your children during your lifetime to lower your estate tax bill. In addition, although you can issue just one class of stock, you can designate voting and non-voting shares, which means you can transfer non-voting stock to your children, allowing them to have more ownership of the company, while you are still in total control of its operations.
Drawbacks of S Corps
The drawbacks of S corps are the restrictions on what corporations can make the S corp election. An S corp can only have 100 shareholders, and those shareholders are limited to U.S. citizens and U.S. residents, estates of shareholders, and certain tax-exempt organizations and trusts. Finally, if the S corp has more than 25 percent of its gross receipts from passive activities, such as interest income or investments, the S corp changes back to a C corp.
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."