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What to consider before starting an S corporation

On Behalf of | Aug 31, 2022 | Business Formation

An S corporation is in some ways a hybrid of a corporation and a partnership. You enjoy better tax benefits like with a partnership but also the personal liability protections of a corporation. It’s a common business structure that small businesses in Massachusetts choose.

Limitations on shareholders

S corporations can’t have more than 100 shareholders. Non-resident immigrants, partnerships and corporations cannot own shares. Only individuals, certain trusts and some estates could be shareholders. The Internal Revenue Code also limits S corporations to one class of stock.

Other eligibility requirements

S corporations must have their headquarters in the U.S. Insurance companies, financial institutions and domestic international sales corporations aren’t eligible for this status.

Filing requirements

The formation of an S corp requires signatures from all of the shareholders. Federal law requires that you pay yourself a reasonable salary as well. To know how much to pay yourself, check the typical market compensation for your role. S corporations consider business owners to be employees.

Less flexibility than an LLC

An LLC might make more sense for your business because it doesn’t have limitations on the number of shareholders. You may also choose to enjoy the tax benefits of an S corp while having an LLC. Limited liability companies allow you to choose the tax structure of a corporation or a sole proprietorship.

Compliance rules

A drawback of setting up an S corporation is there are a lot of compliance rules. Making a mistake could cause trouble for your business. Federal law has rules for elections, stock ownership, consent, notification and filing. You need to use the correct forms for elections and make sure that you complete the election on time for your tax year. Elections don’t need to occur every year, though. All shareholders must consent for an election to happen.