Which Entity Should I Choose? – Part 2: S-Corporation

This is the second part in a series on which type of entity to choose when forming a business. The first part concerned the limited liability company, or LLC.

S-corporations are another popular choice, particularly for small businesses with limited shareholders. S-corporations are created by filing Articles of Organization with the Secretary of State, and by timely electing S-corporation status on Form 2553 filed with the IRS.

The effect of the election is to generally elect pass-through tax treatment. All shareholders must consent to the election.

Like the LLC, the owners of an S-corporation enjoy limited liability, so only their contributions into the S-corporation are at risk of loss (except when the corporate veil is pierced).

The governance of the S-corporation is less flexible than the LLC, however. Management is by a Board of Directors, and annual shareholder meetings are required. Only one class of stock is allowed, and the number of owners is limited to 100 United States citizens and residents.

In some cases, a more favorable tax treatment is available at higher levels of earnings compared to the self-employment tax imposed upon the LLC form.

S-corporations may be appropriate when only one class of stock is needed, the company can generate adequate cash flow, and there is no apparent need to raise investor capital.

S-corporations are not an appropriate choice for companies anticipating more than 100 shareholders, any non-U.S. shareholders, the need for more than one class of stock, or an intent to raise investor capital.