Legal Considerations and Tax Consequences of Forming an S Corporation, With Guest Blogger Ricky Huey

In this blog post, the ladies of Smith Shapourian Mignano LLP collaborate with guest blogger, Ricky Huey, C.P.A., the President of HRH Accountancy Corporation in San Francisco to briefly outline the legal and financial considerations entrepreneurs may face when determining whether an S corporation is the right type of entity for their business.

We met Ricky at a BNI meeting in San Francisco, and are pleased to feature him as a guest blogger for our website.  Prior to owning his own firm, Ricky practiced at Ernst & Young.  He is a member of the California CPA Society and is an American Institute Certified Public Accountant (AICPA).

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Legal Considerations for S Corporations
By: Smith Shapourian Mignano LLP

If you are debating between forming your business as an S corporation as opposed to a C corporation, there are some legal issues you may want to consider:

• Ownership and Stock:  An S corporation cannot have more than 100 shareholders, all of whom own the same class of stock.
• Shareholders:  Shareholders of an S corporation must be natural persons who are U.S. citizens or residents.  So, generally, business entities such as corporations and partnerships cannot be S corporation shareholders.  However, certain charitable organizations, financial institutions, estates, employee stock ownership plans, pension trusts, and single-member limited liability companies (“LLCs”) may be S corporation shareholders.
• Parent/Subsidiary:  An S corporation can wholly own another S corporation, and the subsidiary may be referred to as a “Q-Sub” or a Qualified Subchapter S Subsidiary.
• Pass-Through Taxation, as more fully discussed below.
• Profits and Losses:  Profits and losses are allocated according to ownership percentage.
• Corporate Formality:  S corporations must follow corporate rules (i.e., issue stock, elect officers, hold Board of Directors and shareholders’ meetings, keep corporate minutes, keeping records and transactions of the business separate from those of the shareholders; follow Corporation Code, etc.)

Finally, you may want to consider whether you intend for your business will raise money from investors or venture capital firms and/or go public in the future.  If so, then an S corporation may not be the best fit because of the limitations on stock (one class only) and the number of shareholders (100 maximum).  Moreover, if your company will go public in the future, it must be structured as a C corporation.  For the aforementioned reasons, Investors usually prefer C corporations over S corporations.

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Financial Considerations for S Corporations
By: Ricky Huey, C.P.A., HRH Accountancy Corporation

Small business owners should always consider both the legal and tax impact of entity choices during the formation process.

First, to become an S corporation, you have to make the election on Internal Revenue Service (“IRS”) Form 2553.  

Second, from a tax perspective, there are some advantages and disadvantages between choosing an S corporation, as compared to a C corporation.

Advantages

1. S corporation income is generally only taxed once as a flow-through entity to the shareholders of the S corporation through their personal tax return.  Conversely, a C corporation may face double taxation, once on the corporate level and then again through the individual shareholder level if funds are taken out as a form of dividends to the shareholders.
2. S corporations generally do not have to pay estimated taxes, unlike a C corporation at the federal level.  However, in the State California, there is an estimated tax requirement with a minimum tax of $800.00.
3. After each S corporation shareholder determines a reasonable salary, any additional profits from the S corporation may not be subject to self-employment taxes.

Disadvantages

1. There is only one class of stock, versus several classes of stock for a C corporation, as mentioned above.
2. Many fringe benefits are not allowed for an S corporation major shareholder versus a C corporation shareholder.

These are just a few of the differences in tax implications of filing as an S corporation as opposed to a C corporation.  Generally, if you do not anticipate your business “going public” and you are a small business owner, then filing as an S corporation may be a more favorable option for you, tax-wise.
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Smith Shapourian & Mignano, LLP is available to answer any questions or concerns you may have regarding incorporating your S corporation in California.  Feel free contact us to learn more.

This blog does not constitute solicitation or provision of legal advice, and does not establish an attorney-client relationship. This blog should not be used as a substitute for obtaining legal advice from an attorney licensed or authorized to practice in your jurisdiction. You should always consult a suitably qualified attorney regarding any specific legal problem or matter in a timely manner, as statutes of limitations may bar your claim.