Advantages and Drawbacks of S Corporations (2022 Update)

Compare the benefits and drawbacks of S corporations with those of other corporate forms to decide if they are the best option for your company.

An S corporation is a small business entity that has chosen to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code. When compared to other business forms, such C corporations and LLCs, this corporate structure offers both tax advantages and disadvantages.

Source: S Corporation Advantages and Disadvantages

This article talks you through some of the main benefits of creating a S corporation, such as tax advantages and safeguards for business owners, as well as some potential drawbacks to take into account, like the need for a formal corporate structure and adherence to specific IRS regulations. An S corporation, however, might be a fantastic option for your company if you prepare carefully.



S corporation benefits: Pass-through taxation, limited liability protection, and credibility

No corporate federal taxes 

An S corporation is a unique kind of company entity that provides particular tax advantages. The fact that a S corp is exempt from corporate level federal income taxes is one of its main benefits. Instead, the company's stockholders pay taxes on their proportion of the company's earnings. The business may save a lot of money on taxes as a result every year.

Pass-through taxation is another important characteristic of S corporations. The company itself is exempt from corporate income tax because they are taxed as pass-through companies. The shareholders receive a flow-through of the business's gains, losses, deductions, and credits, which they then record on their personal tax returns.

lower self-employment taxes (FICA payrolls withhold tax)

Self-employment tax is a social security and Medicare tax primarily for people taken from the earnings of the majority of wage workers.

The IRS estimates that the self-employment tax rate in the US is 15.3%, which includes 12.4% for social security (such as old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).

If your net self-employment income was $400 or more, or if your church income was at least $108.28, you are required to pay self-employment tax.

Your capacity to pay less in self-employment taxes is one of the S corp tax benefits. If you are a business's sole proprietor, you usually have to pay self-employment taxes on your company's profits in addition to income taxes. However, with a S corporation, you can opt to solely pay Social Security and Medicare taxes on the salary you receive from the business rather than on the business revenues themselves (Such profits are only subject to the income tax).

high standard of asset protection

S corporations can provide some liability protection for your private property. Your personal assets won't be at risk if they are held in the S corporation if your company is sued or accrues debts that it cannot pay. In the event that your company encounters legal or financial difficulties, this can give you some financial protection and piece of mind.

perpetual existence

S corporations are eternal, or present without end. This is one benefit of a S corporation over a limited liability company, which dissolves upon the death of its members. An S corp may be the finest organizational structure if you want to build a company that will endure after you die.

flexible accounting techniques

S corporations give business owners the freedom to decide how to report their earnings and costs, which can give them more flexibility. With this flexibility, shareholders of s corporations are able to choose the accounting technique that yields the lowest taxable income. For instance, S corporation owners with inventory can choose to employ the cash method of accounting, which defers recognition of inventory until it is sold.

Transferring ownership interests is considerably simpler for S corp shareholders than it is for C corp or owners of other business organizations. Shareholders can transfer their interests to another organization without going through a drawn-out and expensive process.

increased credibility

The increased credibility is one of the key benefits of organizing a business as a S corporation. Being a S corporation demonstrates to potential consumers and clients that you are a serious and reliable company. This can assist you attract new clients and consumers while also retaining the ones you already have.

Similar to this, one benefit of having a S corp is the opportunity to raise cash. You will need to raise funds if you want to grow your company or take it to the next level. Being a S corporation makes it simpler to entice investors and obtain bank loans. This is due to the perception that S corporations are more reliable and secure than other company entities.

S-Corp disadvantages complex duties and stock-related restrictions

additional corporate procedures and tax obligations

The fact that a S company is subject to more rules than other corporate entities is one of its main drawbacks. Evidently, S corporations are required to maintain thorough records of their financial transactions as well as file an annual income tax return (Form 1120-S) and, if necessary, quarterly federal tax filings for employers (Form 941). Additionally, S corporations are only permitted to have a certain number of stockholders, which can reduce their ability to expand. Here, as a S company, you might wish to think about the compliance needs.

restrictions on stock ownership

The decision to form a S corporation may be influenced by ownership limits placed on S corporations 

There are a set number of shareholders 

S corporations are limited to 100 stockholders, all of whom must be American citizens or lawful permanent residents. If the company needs to raise money by selling equity to investors, this could be a drawback.

The election of S corporation status requires the approval of all shareholders 

The business will not be eligible for this organizational structure if even one shareholder objects to the S corporation election.

Certain sorts of shareholders are prohibited for S businesses 

These shareholders include non-resident aliens, partnerships, companies, and other S corporations. This restricts the number of stockholders that a S corporation may have.

increased IRS scrutiny

The IRS pays S corporations additional attention, particularly to the ratio of compensation payments to dividends. The IRS is searching for a decent pay in a S business. If a S corporation's shareholders are also paid as employees, they are required to pay themselves a fair wage.

Conclusion

S corporations have limited liability protection, perpetual existence, and pass-through taxation. S corp status, however, also comes with stringent criteria, including the number of shareholders, the existence of only one class of stock, and US citizenship. Other S company advantages and disadvantages that you may now be aware of include restrictions on who is eligible to become a shareholder.

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