Delaware S corporation qualifications and costs

An S corporation is a way of forming your business that helps protect your personal assets from any corporate liability and avoid double taxation.

In this article, let’s walk through the characteristics of S corporations and get all the facts you need to start your own S corporation in Delaware.

What is an S Corporation?

By definition, an S corporation is a type of federal tax designation, not a formal business structure. This means that you can’t just choose to be an S corp – you must first register as a C corporation or an LLC and meet specific guidelines by the Internal Revenue Service (IRS) in order to qualify.

Registering as an S corp means your corporate income, losses, deductions, and credits will be passed through to shareholders for federal tax purposes. The letter S in S corporation refers to subchapter S of the IRS, indicating the way your business will be taxed.

There are no specific regulations on how you should manage an S corp. Yet, it’s recommended that you appoint a board of directors, hold annual meetings, and set out corporation bylaws to ensure smooth operation.

What are the advantages and disadvantages of Delaware S Corporations?

Advantages

  • Liability and asset protection

S corp allows you to benefit from its liability protection, which safeguards your personal assets from certain risks. That is, you’ll not be personally liable for the company’s debts or liabilities, and creditors are not able to go after your belongings (e.g., your home, savings, etc.) in order to recover business debts.

  • Flexible planning for tax purposes

A Delaware S Corporation gives you flexibility in planning your income for tax purposes, by choosing to have your income taxed as either salary or dividends.

For example, if you receive a salary and are subject to a high tax bracket for self-employment tax, you could classify most of your income as dividends, which are generally tax-free or taxed at a lower rate than your salary.

Make sure you plan your salary and dividends distributions in a reasonable way to avoid being questioned by the IRS.

  • Easy transfer of ownership

Shareholders of S corps can transfer ownership to other people without causing significant tax consequences or terminating the corporate longevity.

Disadvantages

Incorporating as an S corp sounds like a great idea – so why doesn’t every business elect S-corp status? There are some restrictions that may challenges your businesses growth and operation, including:

  • Limited number of shareholders

S Corps can have a maximum of 100 shareholders and cannot be owned by foreign shareholders or by certain trusts or other corporate entities, which restrict its potential to grow in the early operation stage.

Moreover, S corp can only offer one class of stock, which makes it harder for investors to join the company.

  • Complex setup process

You must first form a Delaware Corporation or LLC to elect S corp status, thus the number of paperwork and filing requirements also increase as well. Also, the cost for registering a S corp can be higher than LLC and you’ll have to follow even more regulations and guidelines.

How can you qualify for S corporation status?

Not all corporations can become Delaware S corps. To successfully qualify for S corp status, your business must meet certain requirements set forth by the IRC:

  • Be a domestic corporation based and operating in the United States or a domestic entity eligible to elect to be treated as a corporation. Except for ineligible corporations (i.e. insurance companies, banks, and domestic international sales corporations or export businesses)
  • Have no more than 100 shareholders, who must be permitted (i.e. US citizens or permanent residents and must not be partnerships or other corporations)
  • Issue only one class of stock
  • All shareholders must approve of the election of S corp status

To form an S corp, you must file a Form 2553 with the IRS, proving that your business has met all of the qualifications above.

How much does it cost to register an S Corp in Delaware?

There are generally three types of fees to run an S corp: incorporation filing fee; franchise tax payment; and annual report filing fee.

  • Incorporation filing fees

In order to incorporate an S corp, you will need to file a Certificate of Incorporation, along with the fee to the Secretary of State (SOS).

The filing fee will vary by state, maybe a set fee or based on the number of shares, typically between US$100 and US$250.

You can find the exact fee for your respective state on the SOS website

  • Franchise tax payment

If you incorporate a corporation in Delaware, regardless of where you conduct business, you must file a franchise tax report and pay franchise tax annually (except for exempted domestic corporations). The payment normally ranges from US$175 to US$1,000.

  • Annual report filing fees

S corps are required to pay report filing fees annually, which vary from US$50 and US$200.

How are S corporations taxed?

One of the most defining characteristics of Delaware S corporation is pass-through taxation, meaning that the business itself is not taxed on its profits. Instead, the profits are “passed through” to the shareholders, who then pay taxes on that income when filing their personal tax returns. In other words, S-corps are exempt from a federal corporate income tax, helping the owner to save money on taxes and avoid double taxation.

This also means shareholders who meet certain criteria are able to offset corporate losses with income from other sources on personal income statements.

What is double taxation?

Double taxation means being taxed twice – at the corporate level and personal level. Shareholders have to pay personal income tax on dividends income (at their own bracket’s marginal rate) only after the whole business gains have been taxed at corporate income tax rates (currently at 8.7%).

This arrangement has historically been viewed as the price to pay for a corporation’s limited liability advantages.

Conclusion

If you’re looking for ways to reduce your business taxes, look no further than an S corporation.

BBCIncorp can help you get started on forming an entity and make an election for your Delaware S corporation. Our digital incorporation services can help you get your business up and running in no time. Don’t hesitate to get in touch with us via service@bbcincorp.com or simply chat with one of our friendly consultants.

Frequently Asked Questions

Does Delaware recognize S corporations?

Yes, Delaware recognizes the federal status of an S corporation.

Do S corps have limited life?

S corporations are considered to have unlimited life as their stock and ownership are freely transferable, without causing significant consequences, or interrupting business longevity.

Who can't be a Delaware S corp?

Entities that do not satisfy the following criteria can’t be qualified for S corp status:

  • Domestic corporation based and operating in the United States or a domestic entity eligible to elect to be treated as a corporation. Except for ineligible corporations (i.e. insurance companies, banks, and domestic international sales corporations or export businesses)
  • Have no more than 100 shareholders, who must be permitted (i.e. US citizens or permanent residents and must not be partnerships or other corporations)
  • Issue only one class of stock
  • Approval of the S corp status from all shareholders

What happens if an S corp goes out of business?

You can either dissolve or terminate your S corp status.

To close down your Delaware S corporation, you’ll be required to file a dissolution document, a final tax return in the year you close your business and closure of any state licenses.

For termination of S corp status, you must send a letter to the IRS requesting the termination. The letter must be acknowledged and signed by all shareholders.

Disclaimer: While BBCIncorp strives to make the information on this website as timely and accurate as possible, the information itself is for reference purposes only. You should not substitute the information provided in this article for competent legal advice. Feel free to contact BBCIncorp’s customer services for advice on your specific cases.

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