An S corp is a special type of corporation in the United States, and is often compared to a sole proprietorship or partnership. In a normal or C corporation, the business becomes an entity unto itself and is liable for the contracts that it enters into as well as any obligations, such as product warranty or liability, that are a result of doing business. This normally means that the corporation is also liable for income taxes on the earnings it receives. In an S corp, however, the earnings flow through to the owners. This means that the owners report any losses or earnings on their personal tax returns rather than the company filing separately.
In many ways, this type of corporate structure can combine some of the advantages of incorporation with those of a sole proprietorship. An entrepreneur who is interested in incorporating his business to limit his personal liability may chose to do so with this type of structure, protecting his personal assets in the event of business failure. A simple sole proprietorship or partnership does not provide this protection. A C corporation is often subject to double taxation, however, meaning that earnings are taxed at the federal level both when reported by the company and when reported by the owners as income. Setting up as an S corporation avoids this.
S corps are not treated the same in every state, and some places treat them like any other corporation as far as tax liability goes. For this reason, someone considering setting one up should seek professional legal advice before committing to this type of structure. Even in states that allow S corps to pass earnings through to the entrepreneur, whether or not to incorporate under this structure rather than as a C corporation is a complex tax question, and an entrepreneur should get professional accounting and legal advice on his or her particular situation. While there may be some tax advantages, there are also strict rules that the corporation must follow. In some cases, these rules or restrictions may negate the benefits.
Every company should be assessed individually to determine the advantages and disadvantages of incorporating under this status. The possible benefits are dependent on both the actual and expected earnings of the company, as well as the financial position of the entrepreneurs involved. Fortunately, if a business decides on an S corp structure and the reasons for choosing it change, the corporation can be converted to a C corporation with some minor legal and accounting assistance.