What Is The Difference Between An Partnership and S-Corp?
In today’s fast-paced world, several families get lost in the crowds in terms of wealth building. But in my career as a tax professional and LLC owner, I have seen a great amount of resistance to poverty. Several families are building wealth by earning business income through small businesses they start from their homes. I must say I am happy to see the number of businesses that are coming up. It’s a sign that people are serious about building generational wealth.
Nevertheless, even if you were to form a business, several other impediments still exist—the things like overpaying taxes at corporate level, confusing business structures, and so forth. But not to worry, my job is to help you understand the meaning of your business tax status and what you can do to attain the better one – or the one that allows you to pay fewer taxes.
Therefore, your corporation status can play a role in determining your success level. Remember, when people start family businesses, it doesn’t mean that they all have enough knowledge to get the best out of it. They will just be a bunch of college-degreed professionals who might not have real business running experience. Which is why it is important to first know that how you register your business is important. It is something to think about before filing forms with your state. In this article, I will show you how registering either a partnership or an S-corporation can help you build wealth.
A partnership is a business agreement between two or more people to run and manage a business and share losses and profits. An s-corporation is a closely held corporation that elects to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code. As such, S-corporation is generally a tax status accorded by the IRS.
Benefits of registering your business as a partnership
Anyone can have a business idea and want to turn that into a fully registered business entity. But when many get at this stage, they don’t have an ideal business structure in mind. As time passes, the same person could realize that he or she lacks certain expertise, or that he or she needs extra funding to get started. Now, two things become clear, you need an extra set of hands or brains to provide the expertise you don’t have. Secondly, you need more funding to get things going. This way, you can sell your idea to anyone and offer them a stake in the business. Because you are still new and don’t want to go big, you might agree to become partners. Therefore, registering a partnership can be an easy way to get you extra brains and capital.
More so, partners can still work in the business. There is no dedicated employee than the one with skin in the game. As such, a shareholder will likely be highly productive in your business. In terms of registration, a general partnership does not even need you to register with the state. It means that partners won’t be required to pay a formation filing fee, ongoing state fees, or franchise taxes. All you need is an agreement between partners and start being operational. This really help partners that don’t have money to pay for registration. So, a partnership gives a chance to everyone who wants to build wealth, regardless of what you have in your bank.
Also, partnerships come with a number of tax benefits. A partnership is viewed as a pass-through entity. As such, it is not taxed at corporate level, effectively avoiding double taxation. Partnerships enjoy tax-free property transfers, and they can deduct losses from the business on their own individual tax return.
Looking at the above, you may choose to form a partnership and build wealth faster than with a normal business that is double taxed.
Benefits of electing an s-corporation status
All businesses pay taxes. But some pay fewer taxes than others, for example, an S-corporation. Even though an s-corporation is treated as a partnership, it comes with liability protection for its shareholders. This means that business losses won’t be linked to shareholders.
Besides liability protection, S-corporations enjoy several tax benefits that can help increase their profitability. And, a profitable business helps you build generational wealth. The tax benefits are listed below.
- An S-Corp does not pay Federal taxes at entity level, but shareholders are taxed on their share of income from the business
- Shareholders can be company employees, but they pay much less self-employment taxes than LLC owners
- S-Corp shareholders enjoy the same liability protection as an LLC
- S-Corps pay shareholders, cum employees, salary and the payroll taxes on it. This may save them money on taxes because, just like an LLC, they would pay self-employment taxes on the business’s gross income.
- Additional earnings in an S-Corp are distributed to shareholders as dividends. This may also save money because dividends are taxed at a much lower rate than income.
- S-Corps enjoy a once-a-year tax filing requirement compared to C-corps, which must file quarterly.
On the flip side…
Even though partnerships and the s-corporation status may be good things to happen to a business person, they may still present a few challenges. For example, partnerships do not offer liability protection. This means that owners are not separated from the entity, which could make partners lose assets in case the business cannot pay its debts. More so, both partnerships and S-corporations taxes are due March 15 each year. That is a month before everyone else’s taxes are due. It kind of pressures shareholders to complete their taxes only two months after the festive season.
People also ask the following
1. What Is an S Corporation (S Corp)?
It is a tax-filing status that either a C-Corp or LLC elects for tax paying purposes. This status is obtained by filing Form 2553 with the IRS to apply for S corporation taxation status.
2. How to Start and Form an S Corp
An S-Corp, also known as an S Chapter, is a tax filing status obtained from the IRS. If you want it, first register your small business as a C-Corp or an LLC. Once done, you can file Form 2553 with the IRS within 75 days of your corporation formation. If they are OK with your application, you will obtain the S-Corp status.
3. What is the difference between an LLC and S-Corp?
An LLC and S-Corp both give shareholders limited liability, meaning that their assets are protected against any business losses and liabilities. However, an S-Corp is taxed differently. It is called a pass-through entity in the sense that business income is not taxed at business level, but it is passed through to shareholders, who then report it when filing their personal tax returns.
4. What is the organizational structure of an S-Corp?
S-Corps are first registered as either an LLC or C-Corp before being allocated the S-Corp status for tax purposes. Therefore, the IRS recognizes them as “partnerships” for tax purposes. Shareholders (partners) in an S-Corp are employed by the business and pay themselves ‘reasonable’ salaries, in line with IRS standards.
5. What is the cost of setting up an S-Corp?
Obtaining an S-Corp status is a multi-stage process that begins at your state level. And, you must first register your business as either a C-Corp or an LLC before applying for an S-Corp status with the IRS. State fees to register a business are different across different states. So, visiting your state website to obtain these filing fees will give you the answer you are looking for. Just a heads-up, some states may have a set flat fee, but some may actually have a flexible fee that is determined by the number of authorized shares. If you are to apply using lawyers, be prepared to pay more.
