As a small business owner, you may have chosen to structure your business as an S corporation (S-corp) for tax purposes. While an S-corp can provide many benefits, such as pass-through taxation and limited liability, it is important to follow certain corporate formalities to maintain these benefits.
Corporate formalities refer to the procedures and requirements that an S-corp must follow to operate as a separate legal entity. Failure to follow these formalities can result in the loss of liability protection and the ability to pass through taxes.
Here are a few reasons why it is important to follow corporate formalities as an S-corp owner:
- Maintain limited liability protection
One of the key benefits of operating as an S-corp is that it provides limited liability protection for the business owner(s). This means that the personal assets of the owner(s) are protected from the debts and liabilities of the business.
However, if an S-corp does not follow corporate formalities, a court may determine that the business is not operating as a separate legal entity. This could result in the loss of limited liability protection, and the business owner(s) could be held personally liable for the debts and liabilities of the business.
- Ensure pass-through taxation
Another benefit of operating as an S-corp is that the business is taxed as a pass-through entity. This means that the business does not pay federal income taxes. Instead, the profits and losses of the business are passed through to the individual shareholders and reported on their personal tax returns.
However, if an S-corp does not follow corporate formalities, the IRS may determine that the business is not a valid entity for tax purposes. This could result in the loss of pass-through taxation status, and the business may be subject to double taxation.
- Maintain credibility and professionalism
Following corporate formalities can also help to establish and maintain the credibility and professionalism of the business. By keeping accurate records and holding regular meetings, the business can demonstrate to stakeholders, such as investors and customers, that it is well-run and trustworthy.
- Comply with legal requirements
Corporate formalities also include complying with legal requirements such as filing annual reports, paying taxes, and maintaining proper licenses and permits. Failure to comply with these requirements can result in penalties, fines, and legal disputes.
In conclusion, while following corporate formalities may seem like a burden for small business owners, it is essential for maintaining the benefits of operating as an S-corp. By doing so, you can protect your personal assets, ensure pass-through taxation, maintain credibility, and comply with legal requirements. Consult with a legal or financial advisor to understand the specific requirements for your S-corp and ensure that you are following them accordingly.