s corporations: advantages, taxes, required paperwork and stocks

While S Corporations have some tax advantages it is important to weigh the risks, requirements and greater costs of corporations before making a decision.

Liability Protection

An S Corporation protects the personal assets (home, bank accounts, etc.) of its shareholders. Shareholders are not personally liable for business debts and/or other liabilities of the corporation. If you choose to run your business as an S Corporation and your business goes into debt, your personal assets are protected from creditors.

Taxes

If you organize your business as an S Corporation, you can divide your income into two categories: salary and dividend. You still pay self-employment taxes on the salary portion, but will just pay income tax on the dividend portion. This can help save you big bucks on self-employment taxes by avoiding double-taxation.

It is important to note that S Corporations are generally more expensive to maintain and are often required to pay higher fees than other business entities, so you must carefully determine if the savings outweigh those costs.

The IRS looks closely at S Corporations because there is a greater potential for people abusing the system. For example, if you have an S Corporation that made $100,000 last year, but only claimed $10,000 as personal income and $90,000 as a dividend, you could trigger an IRS audit. Although there is a lot of gray area in this matter, the IRS recommends that you identify a "reasonable" amount as income.

Required Paperwork

S Corporations require more paperwork than a LLC. This can take more of your time, but the advantage is that it gives you a record of your decisions. This can be invaluable for tax and liability purposes.

Following is the required paperwork:
1. Articles of Incorporation
2. Bylaws
3. Memorandum of shares issued (typically 1000 shares of common stock)
4. Organizational minutes
5. Employer Identification Number (EIN)
6. Form 2553

Stocks

An S Corporation can sell stock.

The Articles of Incorporation will indicate the number of shares that are authorized (typically 1000). This is basically a pool of shares that the shareholders can issue "sell" at a later date. The number of shares is arbitrary.

For example, let's say there are 2 shareholders. If they each contributed $500 to the business, and the ownership was split equally between the two partners, for a total of 1000 shares, each share would be worth $1. Alternatively, it could be 100 shares worth $10 per share, or 50 shares at $20 per share...and so on.

WHAT DOCUMENTS ARE INCLUDED WITH MY S CORPORATION:

1- Articles of Incorporation

The Articles of Incorporation is the document that is filed with the state (typically the "Secretary of State" or "Division of Corporations") where the company is planning on doing business. It is very important that the documents are drafted to meet the State requirement. The Articles generally require the following items:

1. The Name of the business. When choosing a business name there are three general rules: (1) the name must indicate that it is a corporation (such as "Inc." or "Incorporated"), (2) the name must be unique and different from any other business that is currently registered in your State, (3) the name must not include words that are restricted by your State (such as "Bank", "Credit Union" and "Trust Company"). When selecting a name, you may want to consider some of the following questions: is the domain name available, how does the name look on the web or as a logo, does it reflect my brand identity?

2. The Shareholders of the business. The Shareholders are the people that legally own stock in the corporation.

3. The Directors of the business. The directors are the people that the shareholders choose to manage the company (such as "President", "Vice President", "Secretary" and "Treasurer")

4. The Registered Agent of the business. The Registered Agent (also known as Statutory Agent or Resident Agent) is an individual or business entity designated to receive mail on behalf of the business. They are also designated to receive service of process (SOP) if the business was a party in a lawsuit. If you are setting up a business in your own State, you will typically name yourself as the Registered Agent. If you are setting up a business in a different State, you will need to hire a company to act as the Registered Agent. The Registered Agent is required to have a physical address in the State where the business is filed.

5. The business purpose. This is simply a description of the business (such as "Real Estate Services" or "Retail Sales").

2- Bylaws

The purpose of the Bylaws is to govern the internal operations of the business (such as what happens if a member dies, or what if a member wants out). It is one of the most important documents because it structures the financial and functional decisions of the corporation.

3- Memorandum of Shares Issued

The Articles of Incorporation will indicate the number of shares that are authorized (typically 1000). This is basically a pool of shares that the shareholders can issue "sell" at a later date. The number of shares is arbitrary.

For example, let's say there are 2 shareholders. If they each contributed $500 to the business, and the ownership was split equally between the two partners, for a total of 1000 shares, each share would be worth $1. Alternatively, it could be 100 shares worth $10 per share, or 50 shares at $20 per share...and so on.

4- Organizational Minutes

The initial Organizational Minutes establish the corporation's structure by appointing directors, issuing shares to shareholders, and approving the Bylaws of the corporation. Each year the directors of the corporation will record Annual Minutes (internally) which indicate what is occurring with your business. Annual Minutes should not be confused with your Annual Report (your State will require you to file a report each year, but don't worry, they will mail you a reminder with instructions). Following are some items that are generally recorded in the Annual Minutes: date and location of your meeting, who attended, a summary of your company actions throughout the year, and a statement indicating any future resolutions. Although the Annual Minutes are not reported, they must be documented in case you were to be audited by the IRS.

5- EIN (Employer Identification Number)

The Employer Identification Number (EIN) is also known as a Tax Identification Number. It is basically a Social Security Number for a business.

6- Form 2553

The Form 2553 is filed with the IRS to let them know how your business is going to report income and calculate taxes.