Understanding the FTC Safeguards Rule: A Business Owner’s Guide
Category: Accounting
Building a company?
One of the first and most crucial decisions you will need to make concerns your business structure.
This choice will impact almost every aspect of your endeavor, from day-to-day operations and management to legal factors such as shareholder liability and tax considerations such as whether or not the business pays tax at the entity level. To make things even more confusing, there are many types of business structures to choose from.
Should your new company be a sole proprietorship, partnership, LLC (Limited Liability Company), or a corporation?
This post is a deep dive into what you need to know about an S corporation. There can be many benefits to this structure, provided it is a good fit for your short- and long-term goals. On the other hand, choosing the wrong structure that doesn’t best serve your business plans can lead to plenty of headaches down the road.
Whether an S corporation is suitable for your company depends on many factors. However, if you’re considering this structure, it’s a good idea to start by gaining a better understanding of what it has to offer for your business.
Read on for your crash course overview of S corporations, including information on:
To begin, let’s dive deeper into this question:
The term “S corporation” means “small business corporation,” and you can find the rules governing this type of entity in Subchapter S of Chapter 1 of the Internal Revenue Code (sections 1361 through 1379).
Essentially, S corporations can enjoy the regular benefits of incorporation while also taking advantage of a partnership’s tax-exemption opportunities.
To put it more simply, an S corporation is an organization that elects to pass income, losses, deductions, and credits through to its shareholders for federal tax purposes.
Regular corporations (or C corps) are subject to the corporate tax rate. Therefore, any money made by the corporation is subject to corporate income and dividend taxation at both the corporate and personal levels. Explaining it another way, the IRS taxes C corps both on the company’s income and any profits the shareholders may receive, which amounts to double taxation on the exact source of income.
However, S corps are pass-through or flow-through entities, which means the income can pass to the owners or investors of the company for tax purposes. This way, S corporations can avoid double taxation and only pay taxes on the income once, at the owner or investor’s personal rate.
S corporations are the most popular business structure in the United States, especially for small businesses. According to the IRS, there are approximately 5 million S corps in the country (three times the amount of C corps).
As mentioned above, S corporations are flow-through entities, meaning shareholders can receive income from the company through salaries or distributions. The shareholder then reports the flow-through income and losses on their personal tax returns, where the IRS taxes the income according to the shareholder’s individual rates.
This type of entity is also subject to certain limitations. For example, an S corporation may not have more than one hundred shareholders, all of whom must be individuals and United States citizens or residents.
There are also restrictions on the sale or transfer of shares and the class of stock. Additionally, an S corporation must pay tax on certain built-in gains and passive income.
Otherwise, an S corp functions much like a C corp because it is a for-profit company governed by state corporation laws. It also offers liability protection and ownership and management advantages and must observe formalities (such as having a board of directors, bylaws, and shareholder meetings), just like a C corp.
In general, incorporating your business can provide many benefits. An S corporation offers:
Incorporation can be beneficial for companies with multiple owners (whereas a business owned and operated by a single person may be better off organizing as a sole proprietorship, for example).
An S corporation structure can be a worthwhile option to explore for any organization that would typically be a C corp but is eligible for S corp status (more on this and other requirements will follow below).
So, why choose an S corp over a C corp?
Simple: to save money at tax time. Not every business will necessarily experience tax savings as an S corp, but your company could gain reduced taxes if it:
Additional benefits of S corp status include the ability to pass net operating losses (NOLs) through to be claimed on the shareholder’s tax return and the fact that net income passing through from an S corp is not subject to payroll or self-employment tax.
To help inform your decision about whether or not to become an S corp, you should also consider the following:
Having considered the above factors, you may next find yourself asking…
While many of the advantages mentioned above can make S corp status very appealing for small business owners, there are also some drawbacks to keep in mind.
For example, there are strict qualification requirements, including the number and type of shareholders and shares. Additionally, an S corporation may have only one class of stock, all shareholders must have equal rights to distributions, special allocations are not allowed, and some loans can cause termination of the S election.
Furthermore, there are many corporate formalities, as mentioned above, a shareholders basis for deducting losses will only increase by a direct loan to an S corp, items such as net operating losses from C corps are not allowed to carry over to an S corp, and the shareholder pays taxes on all income, whether or not the company has distributed it.
Finally, shareholders who hold greater than 2% of an S corp are treated as partners for fringe benefits. Many fringe benefits are not available, and filing taxes for an S corp taxes can be very complex (the corporation must file a federal return and have separate schedules for the tax due from owners).
You’ll need to weigh this information against the potential advantages to your company of making the S corp election. However, if you find that the benefits outweigh the disadvantages, you should ensure that your organization is eligible to become an S corporation.
In order to be eligible to become an S corporation, a company must meet the following requirements:
What’s more, the business must allocate profits and losses according to each owner’s interest in the business, and every shareholder must consent to the S election. The corporation must also continue to meet all of the above requirements to maintain S corp status. For example, if you elect as an S corporation but subsequently add a 101st shareholder, the IRS will revoke your S status, and your company will be double-taxed as a C corp.
Before we outline the steps in becoming an S corporation, it’s important to clarify that you should consider this post a general guide, not specific legal advice.
Having said that, we’ll continue. The first step is to make sure you have completed all the necessary preparations, including naming a board of directors who can meet at regular intervals and drafting corporate bylaws. Next, decide which kind of stock your company will issue and procure a certificate of incorporation. Finally, submit your documentation, file Form 2553 (Election by a Small Business Corporation), and file with a registered agent to receive official correspondence and documentation on behalf of your business.
Although you can take this on by yourself, it is a complex process, and mistakes can lead to costly setbacks. Please reach out if you would like personalized assistance in becoming an S corporation.
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Category: Accounting
Category: Management
Category: Management
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Jeff Coyle, CPA, Partner of Rosenberg Chesnov, has been with the firm since 2015. He joined the firm after 20 years of business and accounting experience where he learned the value of accurate reporting, using financial information as a basis for good business decisions and the importance of accounting for management.
He is a diligent financial professional, able to manage the details and turn them into relevant business leading information. He has a strong financial background in construction, technology, consulting services and risk management. He also knows what it takes to create organizations having built teams, grown companies and designed processes for financial analysis and reporting.
His business experience includes:
Creating and preparing financial reporting, budgeting and forecasting.
Planning and preparation of GAAP and other basis financial statements.
Providing insight on financial results and providing advice based on those results.
Jeff also has a long history of helping individuals manage their taxes and plan their finances including:
Income tax planning and strategy.
Filing quarterly and annual taxes.
Audit support.
General financial and planning advice.
Prior to joining the firm in 2015, Jeff was in the private sector where he held senior financial and management positions including Controller and Chief Financial Officer. He has experience across industries, including construction, technology and professional services which gives him a deep understanding of business.
Jeff graduated from Montclair State University, he is a CPA and member of the American Institute of Certified Public Accountants, New York State Society of Certified Public Accountants and New Jersey State Society of Public Accountants.
Jody H. Chesnov, CPA, Managing Partner of Rosenberg Chesnov, has been with the firm since 2004. After a career of public accounting and general management, Jody knows the value of good financials. Clarity, decision making, and strategy all start with the facts – Jody has been revealing the facts and turning them into good business results for more than three decades.
He takes a pragmatic approach to accounting, finance and business. His work has supported many companies on their path to growth, including helping them find investors, manage scaling and overcome hurdles. His experience and passion for business reach beyond accounting and he helps businesses focus on what the numbers mean organizationally, operationally and financially.
He has a particular expertise in early-stage growth companies. His strengths lie in cutting through the noise to come up with useful, out of the box, solutions that support clients in building their businesses and realizing their larger visions.
Prior to joining the firm in 2004, Jody was in the private sector where he held senior financial and management positions including General Manager, Chief Financial Officer and Controller. He has experience across industries, which gives him a deep understanding of business.
Jody graduated with a BBA in Accounting from Baruch College, he is a CPA and member of the American Institute of Certified Public Accountants and New York State Society of Certified Public Accountants.
In addition to delivering above and beyond accounting results, Jody is a member of the NYSCPA’s Emerging Tech Entrepreneurial Committee (ETEC), Private Equity and Venture Capital Committee and Family Office Committee.
He is an angel investor through the Westchester Angels, and has served as an advisor for many startup companies and as a mentor through the Founders Institute.