1. S Corp Advantages
2. S Corp Disadvantages

An S Corp Company could be the right business structure for you, as it has significant tax benefits and limited liability protection for its owners.

Particularly, the S Corp, which is also referred to as the subchapter or small business corporation, is a better business choice for smaller businesses than a C Corp. It helps in the creation of small businesses and family businesses, while also eliminating the double taxation issue faced by C Corps.

S Corp Advantages

There are several advantages to operating as an S Corp, including the following:

  • Tax exemption
  • Asset protection
  • Flexibility
  • Transfer of ownership

Tax exemption

S Corps are exempt from paying federal income taxes; the only taxes that must be paid at the federal level of some capital gains and passive income, i.e., rent from investment property. S Corps also operate as pass-through entities, as the income and profits from the business pass through to the shareholders (owners), which is then included on the personal tax return. Therefore, the S Corp avoids double taxation.

Asset protection

The assets of the shareholders are protected. For example, shareholders cannot be held personally liable for the S Corp’s debts and obligations. For that reason, creditors also cannot go after the shareholder’s personal assets to recover outstanding debts.

Flexibility

There is greater flexibility in how to classify an owner’s income for tax purposes. For example, you as an owner in an S Corp can also be an employee of the company and pay yourself a reasonable salary.

In addition to paying yourself a salary, you can pay yourself dividends from the business that can be given tax-free or can be taxed at a lower rate than your salary. This helps you to reduce self-employment taxes, as long as you are giving yourself reasonable distribution amounts.

In this sense, the IRS doesn’t want to find out that you are paying yourself an incredibly low salary to avoid paying taxes on such income.

Transfer of ownership

S Corp owners can easily transfer ownership to other owners without causing the business to be terminated, as is the case with most LLCs. In addition, you won’t find that there are any tax consequences if shifting ownership interests to another.

Some other benefits of the S Corp include the investment opportunities that it offers, particularly through the sale of stock. Another benefit is its perpetual existence, as the business continues to exist even after an owner leaves or dies. Yet, another benefit is the fact that the S Corp has only one annual tax-filing requirement, as opposed to C Corps, which must file taxes quarterly. Certain states provide enhanced privacy protection for S Corps, including Nevada and Wyoming.

S Corp Disadvantages

While there are many benefits to operating an S Corp, there are some disadvantages too. One of the biggest disadvantages is that S Corps don’t have the same flexibility in ownership as C Corps, as there can be no more than 100 owners in an S Corp. Another disadvantage is that higher-income shareholders will have to pay more taxes, since such income is paid at the personal tax rate.

Corporations generally have more complex formation requirements than other business structures. Furthermore, corporations generally have higher ongoing expenses, including annual reporting fees and franchise tax fees. S Corps can lose its status if it makes a mistake when filing documents with the IRS.

While one of the many benefits of operating an S Corp is the flexibility in income being distributed as either wages or dividends, it can also present consequences too. As previously noted, the IRS will take notice if you are paying yourself a low salary to simply avoid paying taxes on such income. Therefore, you are at risk of being forced to reclassify your income and pay higher taxes if you aren’t paying yourself properly in terms of dividends and wages.

If you have a non-resident shareholder or stock that is being placed in a corporate entity name, then the IRS will revoke your S Corp status, while also charging back-taxes for a period of three years and imposing a 5-year waiting period before you can gain S status again.

If you need help forming an S Corp, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.