S-Corporation is not a legal entity but a tax status businesses can elect by filing certain forms with the IRS. In order to elect to be taxed as an S-Corporation, you need to first create a Corporation or a Limited Liability Company.
Electing to be taxed as an S Corporation can provide many useful advantages to a business. It is a popular tax election that provides pass-through taxation. Becoming an S Corp makes it easier for your company to grow, protects shareholders against legal liability and ensures that the businesses tax rate is kept as low as possible. This guide will take a closer look at S Corporations Election and explain how to become an S Corporation in Florida.
What is an S Corporation?
An S Corporation is a business tax election available to businesses in the United States. S Corporations tax election was introduced in 1958 by the federal government to help small businesses and families obtain the protection and ownership flexibility of a corporation without the risk of double taxation.
Double taxation is avoided by S Corps thanks to pass-through taxation rules, where all income, losses, deductions and credits are divided and passed through to the shareholders of the company. This means that Florida S Corporations are only responsible for taxes relating to built-in gains and passive income.
The shareholders in the company will be responsible for reporting losses or profits relating to the business on their personal tax returns. Profits will be taxed at the individual’s personal income tax rate, not at the corporate rate. S Corporation rules can be found in Subchapter S of Chapter 1 of the Internal Revenue Code (sections 1361 through 1379).
In order to Elect to be taxed as an Corporation, your business needs to have a separate legal entity like a Limited Liability Company or a Corporation. These entities provide the owners of the LLC or the Corporation with a high degree of protection from legal action.
How is an S Corp Election different to a C Corp Tax Status or LLC Tax Status?
Pass-through taxation Both S Corporations Election and LLC Default Tax Status have pass through taxation. A C Corporation does not. Pass-through taxation allows all income generated by the S Corp to flow through to shareholders and be treated as personal income on tax returns. C Corporation Tax Status must pay corporate tax rates and must take steps to avoid double taxation when passing profits onto shareholders. An S Corporation and LLC Default Tax Status does not have its own income tax liability.
Reduced taxation liability for self-employment Companies that elect to be taxed as S-Corporation enjoy reduced liability for self-employment taxes compared to partnership or corporation tax status. That’s because S Corporation shareholders only pay self employment tax rates on the salary they receive from the business, not on business profits that are allocated to them.
Florida S Corporations are limited to 75 shareholders S Corps registered in Florida can have a maximum of 75 shareholders. This differs to C Corporations and LLCs which can have an unlimited number of shareholders or members.
Restrictions on starting an S Corporations
While an S Corporation offers businesses some excellent advantages, it might not be right choice for every business. The following restrictions apply:
Florida S Corporations can only have 75 shareholders
The shareholders of Florida S Corporations must be legal residents of the United States or be US citizens
Florida S Corporations can only have one class of stock
Your Florida S Corporation must be a domestic business entity
These restrictions may conflict with your long term business goals or rule your business ineligible. If there are foreign shareholders involved or you want to have more than 75 shareholders, a C Corporation is a more appropriate choice. It has no limitations on the number of shareholders or their nationality.
Businesses can obtain many advantages by registering as an C Corporation in Florida, including:
Limited liability protection S Corporations are treated as separate legal entities. That means shareholders are protected from its debts and liabilities. They will not be held legally liable for the actions of the corporation unless they commit a criminal offense or fail to uphold corporate rules and regulations. If the business goes bankrupt, the personal assets of shareholders will remain safe.
Various tax advantages Florida S Corporations do not pay federal income tax. However, they may have to pay tax on passive income and capital gains. The corporation can pass profits directly onto its shareholders and those profits will be taxed at the individual’s income tax rate. This avoids the problem of double taxation, which can occur when shareholders receive dividend payments from a C Corporation.
An S Corporation also gives shareholders flexibility in terms of how income is characterized. Shareholders can be employees of the company and receive an income from the business plus dividends, which are tax-free or taxed at a lower rate than income tax. You can customize how you distribute proceeds of the business to enjoy limited self-employment tax liability and tax deductible losses. There is a much lower risk of being audited if your business is an S Corporation.
S Corporations can continue indefinitely Florida S Corporations have perpetual existence. They can continue doing business even if the founders of the company sell their shares or die suddenly. This is a different arrangement to sole proprietorships or partnerships, which are tied to specific people.
Easy transfer of ownership The ownership of Florida S Corporations can be transferred easily, with only a few restrictions on who can hold shares. There are no significant tax consequences that occur when shares are transferred and no onerous compliance requirements or accounting rules.
Corporations law is well established in the USA Corporations are the oldest form of business entity recognized by the United States government and S Corporations have been around for more than 60 years. The laws surrounding corporations are well established and hold no surprises for businesses.
S Corporation do not have to file a tax return in Florida Florida does not require an S Corporation to file a tax return unless it has experienced excess net passive income, last-in first-out (LIFO) recapture, or Built-in Gains.
It is easier for S Corporations to raise money S Corporations can easily raise money by selling more share of the business to other investors.
Separation between ownership and management
Florida S Corporations can be organized so there is a separate management team that does not own a part of the business. This is different to other business entities like sole proprietorships, partnerships, and LLCs.
S Corporations have more credibility Businesses that are registered S Corps have more credibility than partnerships or sole proprietorships. Investors, customers and other businesses will see your enterprise as being more professional.
Drawbacks of an S Corporation
Unfortunately, there are some drawbacks associated with this business structure, including:
There are some restrictions on ownership Florida S Corporations have more restrictions on ownership than C Corporations do. As mentioned earlier, they have a hard limit on the number of shareholders. Additionally, S Corps cannot be owned by other corporations, foreign nationals, or trusts.
Tax mistakes can cause an S Corporation to lose its status If the IRS discovered that your corporation has given them incorrect information on the businesses stock ownership, election to be an S Corp, or failed to declare income appropriately, it may lose S Corporation status.
The IRS may not like re-characterization of wages and dividends S Corporation shareholders employed by the business can choose how to receive income from the business, electing to have it characterized as wages or dividends. However, the IRS is very aware of business owners using this advantage and may take action if your company appears to be exploiting the tax code.
How to form a new S Corporation in Florida
Forming an S Corporation includes the following steps:
Step 1: Creating a corporation An S Corporation is formed in a similar way to a C Corporation or LLC. Your business must lodge filing articles with the Florida Division of Corporations (DOC). However, there are certain pre-formation logistics that must be completed before filing with the Florida DOC. They include:
Choosing a company name Choosing a name for your S Corporation is not as straight forward as you might think. It must be a unique and distinguishable name, which is available with the Florida Department of State, Division of Corporations (DOC). The name cannot make your corporation appear as if it is related to the government or a charity. If you intend to use the name of your business as a trademark, trade name, or domain name, searches should be conducted with the US Patent and Trademark Office before applying.
Articles of Incorporation are created and submitted The Articles of Incorporation are a set of formal documents that are filed with the Florida Secretary of State. They contain information identifying the business and the people involved. Some of the information detailed in this document will include:
Statement of purpose The document will describe why the corporation has been established and what its principle purpose is. It will describe what products or services are sold by the corporation and who will be buying them.
Members Who the initial members of the corporation are. This section will detail how often management will meet, how voting rights work and much more.
Board of directors Directors should be nominated. This may require a vote by the shareholders of the company.
Shareholder’s meetings Details of how and when shareholder meetings will occur should also be included. This section can explain the quorum required to vote at these meetings and the order of business that will be followed.
Stock This section will explain how much stock will be issued initially, who will receive it, and how it is transferred. Details of the voting rights and dividends associated with shares should also be mentioned. You may wish to include details regarding redemption rights, rights of first refusal, and anti-dilution rules.
Officers Officers usually include the President, Vice President, Chief Executive Officer (CEO), Chief Financial Officer (CFO), and Treasurer. You should specify who will fill these roles, what their remuneration is, and what their key responsibilities are.
Annual reporting requirements You may wish to specify who will be responsible for annual reporting requirements.
Incorporation bylaws You may wish to include details of how the company will be structured and governed.
Issue shares to investors Stock certificates should be created and given to shareholders in the company.
Apply for a business license, certificates and identification numbers A new corporation will have to apply for a business license from Florida authorities. It may have to also apply for certificates and identification numbers.
Obtain an Employer Identification Number (EIN) from the IRS If your company has employees, it will have to obtain an EIN from the IRS.
Step 2: Satisfy S Corporation election requirements
Your corporation must be a “small business corporation” to receive the tax treatment of an S Corporation (as defined in Section 1361(b)(1) of the Internal Revenue Code (IRC)). A small business corporation must:
Be a domestic corporation
Have under 75 shareholders
NOT have non-resident shareholders, certain exempt organizations or trusts as shareholders
Only have one class of shares
Certain types of corporations cannot become S Corporations, including insurance companies taxable under subchapter L of the IRC, banks that uses the reserve method of accounting for bad debts under Section 585 of IRC, and current or former domestic international sales corporations.
No more than two months and 15 days after the beginning of the tax year the election is to take effect, or
At any time during the tax year preceding the tax year it is to take effect.
The IRS will notify you if your application has been successful within 60 to 90 days. Your businesses S Corporation status will remain in place permanently unless it is revoked or terminated.
Should I Setup an S Corp in Florida?
Creating an S corporation in Florida is about defining the tax status of your business. Starting an S corp in Florida allows small business owners to avoid double taxation and benefit from reduced personal liability.
To make sure you dot your I’s and cross your T’s, hire an experienced S corporation formation lawyer. The attorney will show you the naming requirements and provide professional insight into identifying the first directors and officers.
Also, by having an attorney on your team, you are more likely to be sure your business meets the qualifications for S corporation status, from not exceeding 100 shareholders to holding required elections and filing the correct forms with the IRS. If you are interested in forming a S Corporation in Tampa, Florida and want to make sure it is done right, contact our law office today so our proven business attorney can help!
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