All entrepreneurs want to see their Kentucky businesses achieve growth and success. While business growth is exciting and rewarding, it also comes with new challenges. In most cases, it will lead to an increase in tax rates. That means you will have to face complexities during tax season.
To deal with the situation, business owners will have to evaluate their circumstances and make a big decision. For many entrepreneurs, the most beneficial option is to elect an S Corp. This status comes with significant advantages when it comes to taxation while retaining the flexibility of the business entity structure.
Understanding What It Is
S Corp stands for subchapter S corporation. But, some people know it as a small business corporation. What you have to keep in mind is that it is not a business entity structure. It is a tax code.
Congress first enacted this tax code in 1958 to encourage and support small businesses and family companies by eliminating double taxation, which is something that conventional corporations face.
The main characteristics of an S Corp are similar to that of a traditional corporation, which is known as C Corp. However, businesses that elect S Corp status will be taxed as a partnership. So, if a company has this tax code status, it does not have to pay for federal income taxes. The tax liabilities will be passed through to the owners of the company. Additionally, the company will be a single entity no matter how many individuals organized it.
To help you better understand this tax code, here are its main characteristics:
- No double taxation
- Pass-through taxation
- Limited liability protection
- Has no more than 100 shareholders at a time
- Only one type of stock
- Transferable stock
- Has to be a domestic business entity
- All owners are US citizens or legal residents of the US
- Business entities cannot serve as owners or directors
If you choose to elect S Corp status for a company that is registered in Kentucky, then you will have to know the advantages that it offers. Here are some of them:
- Limited Liability – As stated earlier, this status comes with liability protection. That means that the shareholders of an S Corporation will not be held personally liable for all legal judgments against the company or the debts and obligations it incurs. Generally, the owners cannot lose more than their investment.
- Raising Capital – S Corporations in the state can issue or sell stock as evidence of interest in the company. That makes it easier for them to raise additional capital. However, an S Corp can only have one class of stock.
- Taxation – Aside from being a pass-through entity when it comes to taxation, S Corps are often audited less frequently than partnerships and sole proprietorship. While the company has to submit informational tax returns, it does not have to pay income taxes. Instead, the shareholders will report their share of profits and losses on their individual tax returns. The allocation of profits and losses will depend on the ownership percentages of the shareholders.
- Owners and Employees – Kentucky owners who work in the company are considered employees. So, they will be eligible for certain fringe benefits. However, there will be limitations for major shareholders.
- Duration – S Corps usually have perpetual existence. So, even if a shareholder dies or leaves, the company continues to exist.
Who Cannot Apply
Electing S Corp is beneficial for many Kentucky businesses. However, not all companies qualify for it. There are certain types of general corporations that do not qualify based on the requirements of the Internal Revenue Services (IRS). If your company falls for any of the following types, you cannot start an S Corp.
- Insurance companies taxed under subchapter L
- Domestic International Sales Corporations (DISC)
- Certain affiliated groups of corporations
Starting a Kentucky S Corporation: The Basics
The rules for electing S Corporation status are similar since companies will have to apply with IRS. But, you need to have a company listed in the state business registry first.
To help you get started, here is a simple step-by-step guide:
Step 1: Form a business entity.
As mentioned earlier, S Corp is a status and not a business entity structure. So, the first thing you have to do is to register a business with the state. You can form a limited liability company (LLC) or a corporation. Choose the one that is most beneficial for your circumstances.
If you choose an LLC, then you will have to file the Articles of Organization and pay the $40 fee. Meanwhile, forming a corporation requires you to submit a completed Articles of Organization and pay $50. File the appropriate paperwork with the Secretary of State.
You should also take note of the naming guidelines in the state. Your company name has to contain the appropriate designator. For LLCs, it can be the phrase Limited Liability Company or any of its abbreviations. Corporations can use the term corporation, company, incorporated, limited, or any of their abbreviations. You cannot use a word that could confuse your company with a government agency. Certain restricted words may require additional paperwork.
Additionally, you should also ensure the distinguishability of your company name. That means you cannot use a name if it is already taken. You will have to do a name availability check in the business registry of the state to find out if no other entity uses your desired name.
If you happen to have a name in mind but are not yet ready to formally register the business, you can choose to reserve it for 120 days. To do this, submit a Name Reservation form to the Secretary of State and pay the $15 filing fee.
Step 2: Nominate a registered agent.
All companies operating in Kentucky have to appoint a registered agent. You can nominate an individual, who is at least 18 years old and a resident in the state. Another option is to select a third-party organization like DoMyLLC that is authorized to do business in the state. To check the qualifications for a registered agent, read this article.
Step 3: Get an Employer Identification Number (EIN).
Obtain an EIN from the IRS. You will use it for tax filing, opening a company bank account, and hiring employees.
Step 4: Issue stocks and prepare initial documents.
If your company starts as a C Corp, then you will have to issue stocks to shareholders. You should also prepare the bylaws of your organization. To qualify for S Corporation, you will have to remember the limitations on the capital structure as well as the nature of shareholders.
Step 5: Elect the Subchapter S Corporation.
Once you formally register your business entity with the state, you can proceed to the election as S Corp. File a completed Form 2553 to the IRS. The agency will evaluate your company’s application and determine if it is eligible for the said tax code status.
You should also remember that the tax code status will only affect the taxation of your company. The business entity will retain the other obligations of its original structure.
To maintain the status, you will have to ensure that your company does not take on more than 100 shareholders at a time or additional stock classes.
Choosing to elect S Corp tax status for your business entity comes with many advantages. However, it requires you to go through a process. That includes the submission of formal paperwork. You also need to ensure that your company remains compliant with all of its state obligations.
If you think you need help in handling formal paperwork or state compliance obligations, then contact a reliable third-party organization like DoMyLLC. Our team of experts has the necessary skills and knowledge to help make the whole ordeal hassle-free for you.
We can also serve as your registered agent in the state. Additionally, you can also request for a personalized solution to ensure that the service we give you fits the needs and circumstances of your company. We also offer live support to answer queries.
Business Filing Section