Incorporating a business is an effective way to protect personal assets from business liabilities. One of the disadvantages of incorporating a business is the potential for double taxation. Not only does the company pay taxes on income earned doing business, the shareholders of the company may also be required to pay personal tax on income withdrawn from the business.

An alternative to forming a regular corporation, also known as a C corporation, is an S corporation. This business structure provides several tax advantages to their shareholders.

Tax Advantages of S Corporations

The primary benefit of S Corporations is the reduction in payroll tax obligations. The tax rate for C corporations is 15 percent to 35 percent. This is paid on all income earned by the business minus any tax deductions the business qualifies for. When the shareholder is paid by the business, they are also subject to a personal tax rate dependent on their level of income. For example, if they are paid $50,000 then they could be liable for 25 percent in personal taxes.

S corporations reduce the tax obligation to one level. Typically, the percentage rate charged is about 15 percent. Additionally, the tax is only charged on what the shareholders take out of the business.

Other Tax Advantages

* Shareholders can claim losses incurred by the S Corporation as deductions on their personal tax returns.

* Corporate profits left in the business are not taxed by the federal government. However, they may be subject to taxation by the state.

Forming an S Corporation

* The decision to form an S corporation must be made early in the incorporation process. It may not be possible to change from a C corporation to an S corporation once the entity is formed.

* Articles of incorporation must be drawn up similar to the formation of a C corporation. Additionally, the corporation must be formed in the state where the majority of its business will be conducted.

* The corporation must meet the criteria set by the IRS in order to qualify for S Corporation status. The company must be a domestic business, have less than 100 shareholders who are all U.S. citizens or resident aliens, and only one class of stock. An attorney specializing in incorporation can provide more information about these requirements.