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The Pros & Cons of Using an S Corporation Structure

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An especially popular tax or business structure among small businesses, the number of S Corporations has quadrupled in the past 15 years and by far is the most common form of doing business except for the unincorporated sole proprietorship. However, whether it is an appropriate choice for your new business depends on your particular facts and circumstances.

Some of the Advantages of Operating a Business as an S Corporation:<

  • Your personal assets will not be at risk because of the activities or liabilities of the S Corporation (unless, of course, you pledge assets or personally guarantee the corporation's debt).
  • Your S Corporation generally will not have to pay corporate level income tax. Instead, the corporation's gains, losses, deductions, and credits are passed through to you and any other shareholders, and are claimed on your individual returns. The fact that losses can be claimed on the shareholders' individual returns can be a big advantage over regular corporations. Liquidating distributions generally also are subject to only one level of tax.
  • The S Corporation has no corporate alternative minimum tax (AMT) liability (however, corporate items passed through to you may affect your individual AMT liability).
  • FICA tax is not owed on the regular business earnings of the corporation, only on salaries paid to employees. This is a potential advantage over sole proprietorships, partnerships, and limited liability companies.
  • The S Corporation is not subject to the so-called accumulated earnings tax that applies to regular corporations that do not distribute their earnings and have no plan for their use by the corporation. Nor, because of their pass-through nature, do they risk being characterized as a personal holding company.
  • Many S Corporations qualify for a fiscal year<—Despite what you may read on the Internet.

 

Some of the Disadvantages:<

  • S Corporations cannot have more than 100 shareholders (but with husband and wife being considered as only one shareholder). Further, no shareholder may be a nonresident alien<.
  • Corporations, nonresident aliens, and certain estates and trusts cannot be S Corporation shareholders. Electing small business trusts, however, can be shareholders, a distinct estate planning advantage.
  • Losses that can be claimed are subject to what are known as the passive loss limits—S corps pay tax at the highest corporate rate on their excess passive income
  • S Corporations may not own subsidiaries, which can make expansion difficult, unless the subsidiary is a qualified Subchapter S subsidiary (a 100% owned S Corporation or QSub); and termination of the QSub's status can be treated as a sale of assets.
  • S Corporations can have only one class of stock (although differences in voting rights are permitted). This severely limits how income and losses of the corporation can be allocated among shareholders. It also can impair the corporation's ability to raise capital.
  • A shareholder's basis in the corporation does not include any of the corporation's debt, even if the shareholder has personally guaranteed it. This has the effect of limiting the amount of losses that can be passed through. It is a disadvantage compared to partnerships and limited liability companies, and is one of the main reasons that those forms are usually used for real estate ventures and other highly-leveraged enterprises.
  • S Corporation shareholder-employees with more than a 2-percent ownership interest are not entitled to most tax-favored fringe benefits that are available to employees or regular corporations.
  • An S Corporation may be liable for a tax on its built-in gains, if, among other things, it was a C corporation before making its S Corporation election.

Some of these factors will be more important than others, depending upon the particular circumstances. If you would like to pursue this matter further, and have us help you fully evaluate your situation, please do not hesitate to contact us<.