S Corporation Qualifying for S Corporation Status S-Corporation: To qualify, generally, the corporation must have a maximum of 75 shareholders who are individuals (though certain types of trusts and estates may qualify). Once a corporation makes the Subchapter S election to be an S-Corporation, profits and losses are passed through the corporation and are reported on the individual tax returns of the respective shareholders of the S-Corporation. This is the same basic "pass-through" treatment afforded partnerships and LLCs. Thus, the key distinction of the S-Corporation is that profits and losses are not taxed at the corporate/business level like they would be if the corporation remained as a C-Corporation. Corporate Formalities An S-Corporation follows the same state formalities as does a C-corporation (i.e. filing Articles of Incorporation and paying state fees). However, an S-Corporation must make a special tax election under sub-chapter S of the Internal Revenue Code by filing IRS Form 2553. IRS Filing The S-Corporation must complete and file IRS Form 1120s to report its annual income to the IRS each year. General Shareholder Requirements ALL shareholders of the corporation must be U.S. Citizens or have U.S. Residency Status. If, for any reason, shares are somehow sold or transferred (even if by will, divorce, or other means) to a shareholder who is a foreign national, the corporation will lose its S-Corporation status and be treated as a C-Corporation. 75 Shareholders Maximum. Only One Class of Stock S-Corporations may have only one class of stock. Losing S-Corporation Status An S-Corporation that loses its status as such may no re-elect S-Corporation status for a minimum of five years. Who should elect S-Corporation Status Owners who want the limited liability of a corporation and the "pass-through" tax- treatment of a partnership will often make the S-Corporation election. California State Incorporation Fees (required) $100.00 OBTAIN Employer Identification Number (IRS form SS-4) Corporate Seal and Embosser ?? Need a name check for name availability within the state of incorporation. Never rely on a corporate name check until AFTER you have received a copy of your filed Articles of Incorporation, stamped with the state's approval. A Federal Tax Identification Number (also known as a "95 Number" or "EIN Number" ) is a number assigned to a corporation or L.L.C. by the Federal Government for purposes of taxation. The Federal Tax ID Number is to a corporation or L.L.C. as a Social Security Number is to an individual. Most banks require that a corporation or L.L.C. obtain a Federal Tax Identification Number as a prerequisite to opening a bank account regardless of whether the company will have employees. Federal Tax Identification Number Application (IRS Form SS4) Corporate Formalities A corporation can be created only by compliance with General Corporation Law of the state of incorporation. This usually requires filing of Articles of Incorporation with the appropriate state entity (usually the Secretary of State) and payment of the requisite state fees and taxes. A corporation is required to have a board of directors, corporate officers, annual shareholders meetings, and to maintain separate books and records. Failure to observe such formalities may result in the personal liability of shareholders for corporate debts. However, where the corporation has only one shareholder, many states allow that one shareholder to act as director and all officers (President, Secretary, and Treasurer). Where to Incorporate: Under which state’s laws should a corporation be formed? State laws governing corporations vary from state to state. However, if the corporation will have significant business or shareholder contacts (a.k.a. "presence") within a state, there is usually not much reason to incorporate outside of that state. For example, forming a California corporation for a business centered in California is usually the logical choice for the following reasons: Filing Fees: An out-of-state corporation that will be conducting business in California must "qualify" to do business in California. This "qualifying" requires the corporation to pay filing fees to the California Secretary of State in addition to whatever filing fees were paid in the state of incorporation. State Taxes: An out-of-state corporation doing business in California will have to pay franchise taxes to California. The corporation may also have to pay franchise taxes in its state of incorporation (even if the corporation is not conducting business in that state). Thus, the corporation is potentially exposed to taxing by more than one state. Securities Laws: The California Corporate Securities Laws apply to any offer or sale of a security "in this state" regardless of the issuer’s state of incorporation. Corporate Rules: Regardless of where the corporation is formed, many provisions of the California Corporation Law, for example, apply if the corporation has a sufficient "presence" in California. What is the difference between a corporation and an LLC? Corporations are formed pursuant to state law and have shareholders, are managed by a board of directors, and the daily affairs are administered by officers. Similarly, a limited liability company (LLC) has members and may be managed by one or more managers. Most often, both entities must pay franchise taxes, but may have different federal tax liabilities. Generally, most people form corporations or limited liability companies in order to shield the shareholders or members and officers or managers from personal liability for the debts and obligations of the entity. There may also be various tax advantages to forming these entities which may not be available for sole proprietorships and general partnerships. Duration of Corporation Compared to LLC An LLC has a limited existence. Absent a contrary agreement, a limited liability company (LLC) is dissolved upon the death, withdrawal, or bankruptcy of a member unless the business is continued by unanimous vote of the remaining members. Although the operating agreement can be drafted to avoid such a result, the life of the LLC is still limited to the termination date in the Articles of Organization. Advantages of an LLC In general: An LLC is a hybrid between a partnership and a Corporation in that it combines the "pass-through" treatment of a partnership with the limited liability accorded to corporate shareholders. Two members required: Unlike a corporation which can have as few as one shareholder, most states require that an LLC consist of two or more members (owners). Separate Legal Entity: Like limited partnerships and corporations, an LLC is recognized as a separate legal entity from its "members." Limited Liability: Ordinarily, only the LLC is responsible for the company's debts thus shielding the members from individual liability. However, there are some exceptions where individual members may be held liable: Guarantor Liability: Where an LLC member has personally guaranteed the obligations of the LLC, he or she will be liable. For example, where an LLC is relatively new and has no credit history, a prospective landlord about to lease office space to the LLC will most likely require a personal guarantee from the LLC members before executing such a lease. Alter Ego Liability: Very similar to the judicial doctrine applied to corporations where a court may hold the individual shareholders liable where the business entity is merely the "Alter Ego" of its shareholders, a member of an LLC may also be held liable for the LLCs debts if the court imposes its "alter ego liability" doctrine. Please note, however, that although a corporation's failure to hold shareholder or director meetings may subject the corporation to alter ego liability, this is not the case for LLCs in California. An LLC's failure to hold meetings of members or managers is not usually considered grounds for imposing the alter ego doctrine where the LLCs Articles of Organization or Operating Agreement do not expressly require such meetings. Management and control: Management and control of an LLC is vested with its members unless the articles of organization provide otherwise. Voting Interest: Ordinarily, voting interest directly corresponds to interest in profits, unless the articles of organization or operating agreement provide otherwise Transferability: No one can become a member of an LLC (either by transfer of an existing membership or the issuance of a new one) without the consent of members having a majority in interest (excluding the person acquiring the membership interest) unless the articles of organization provide otherwise. Duration: An LLC does not have a reliable continuity of existence. The articles of organization must specify the date on which the LLC’s existence will terminate. Unless otherwise provided in the articles of organization or a written operating agreement, an LLC is dissolved at the death, withdrawal, resignation, expulsion, or bankruptcy of a member (unless within 90 days a majority in both the profits and capital interests vote to continue the LLC) Formalities: The existence of an LLC begins upon the filing of the Articles of Organization with the Secretary of State. The articles must be on the form prescribed by the Secretary of State. Among the required information on the form is the latest date at which the LLC is to dissolve and a statement as to whether the LLC will be managed by one manager, more than one manager, or the members. To validly complete the formation of the LLC, members must enter into an Operating Agreement. This Operating Agreement may come into existence either before or after the filing of the Articles of Organization and may be either oral or in writing.
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