Corporations represent one of the most popular types of business entities. While some businesses become C corporations, others elect to become S corporations.
Owners can choose the type of business when filing Articles of Corporation with the Office of the Secretary of State of New York. If they do not indicate a preference, the business will become a C corporation by default. A business can, however, elect to become an S corporation at some point in the future.
S corporation requirements
To become an S corporation, a business must meet certain requirements:
- It must have no more than 100 shareholders
- It must issue only one type of stock
- Every shareholder must be either a U.S. citizen or a permanent resident of the U.S.
- No S corporation owner can be another corporation, a Limited Liability Company or a general partnership
Taxation is a key area where C and S corporations differ. C corporations pay corporate income taxes and their shareholders also pay personal income taxes on the dividends and/or salaries they receive. S corporations, on the other hand, pay no corporate income taxes. These get passed through to the shareholders, who once again pay personal income taxes on their respective dividends and/or salaries.
S corporations used to be the preferred choice when possible because of the favorable tax benefits they and their shareholders received. The 2018 Tax Cuts and Jobs Act changed all that when it lowered the corporate tax rate from 35% to 21% beginning in 2019. This resulted in an average effective 17.5% tax rate for C corporations, while S corporations still face an average effective tax rate of 26.9%.
The TCJA also makes computing S corporation shareholders’ taxes considerably more difficult. While shareholders can generally take a 20% deduction on “qualified business income,” numerous restrictions apply. They have to consider such things as their W-2 business income and capital gain income.