As you form your new business, you want to create a business entity that enables you to thrive. You want your company to save as much as possible on taxes while letting you grow successfully. One type of structure that you can consider is an S-corporation, or S-corp.
An S-corp is a corporation that offers tax benefits to shareholders. It can be a great option for small businesses that wish to avoid double taxation.
Choosing a tax designation
When you designate a business as an S-corp, you are selecting the tax designation. The S-corp lets you and all other shareholders report the profits and losses of the company on personal tax returns. This “pass-through” taxation avoids corporate taxation.
The tax benefits of an S-corp
The main advantage of this type of taxation is the avoidance of double taxation. In a traditional corporation, also called a C-corp, the company pays taxes on profits and losses. Then shareholders pay personal taxes on dividends they receive from the business. Shareholders of C-corps can lose a significant amount of money to the IRS.
Unlike a C-corp, an S-corp also lets you write off the losses of the business on your personal tax return. Writing off losses can be advantageous in the early years of your company when you spend money to grow the business.
Limitations on S-corps
However, not all businesses may benefit from the S-corp designation. S-corps can help small companies but may not be right for larger businesses.
If you have a large company that plans to add many shareholders, including foreign investors, you may want to keep your business as a C-corp.
S-corps have limitations on the number of investors. And only U.S. citizens or residents can be shareholders.
Choosing the right entity for your business
The business entity and tax designation that works best for you will depend on how your business grows. You may even start as an S-corp and then switch to a C-corp further down the road. But if saving money on taxes is more important to your business model, you may want to consider the advantages of an S-corp.