Starting up a business involves many decisions, including which type of business entity to choose. For example, a business might operate as a sole proprietorship, partnership, limited liability company, or corporation. But there are two basic kinds of corporation – a C corporation and an S corporation. Before deciding whether an S Corporation is right for you, it’s good to explore the advantages and disadvantages of your decision.

Forming a Corporation

A corporation is a legal entity with its own identity, separate and apart from its stockholders. Corporations generally can issue stock, make decisions, own property, and be sued.

In Alabama, you may form a corporation under the laws of Alabama by following the Secretary of State’s procedures. However, by default your corporation is a “C” corporation, not an S corporation. The Internal Revenue Code Subchapter S allows for the formation of S corporations. Therefore, you must file an IRS Form 2553 to elect “S” Corporation status or the IRS will view your company as a C corporation.

But why would a corporation want to take this extra step?

Advantages to S Corporations

Shareholders of both C corporations and S corporations enjoy some limited liability and protection against lawsuits filed due to corporate actions. However, there is one compelling reason to file the extra S election paperwork:

  • Taxation. The S election provides a special type of federal tax status to the shareholders. Owners are taxed as individuals because the S corporation is a pass through entity. Shareholders of C corporations are taxed at both the individual and corporate level. Sometimes this is called double taxation.

In practice, S corporations issue a Schedule K-1 to each shareholder. This shows how much income or dividends was allocated to each owner. The owners then report this income on their individual tax returns, with the corporation itself filing a corporate tax return.

Assess Your Needs Before Choosing to Form an S Corporation

Before starting a business, or converting your current business to an S corporation, talk to a business lawyer. You may be well-served by making that S election, but it’s important to understand all the implications. For example, S corporations are limited to a certain number of shareholders and only one stock class. Is that the best structure for your business?

Attorney Bruce Adams helps clients just like you with their legal needs. For a free consultation with an experienced Alabama attorney, contact us at 256-237-3339. Located in Anniston, we serve clients in Calhoun, Cleburne, Etowah, and St. Clair Counties.