Last Updated on July 16, 2024 by Team Experts
Running your own business is a rewarding experience, but it comes with a lot of responsibility. One of the most important decisions you can make is deciding what type of business entity to form. One option is to form an S corporation, which has several benefits over other business structures.
Advantage of Pass-through Taxation
Pass-through taxation is the taxation of business entities where the business income “passes through” to the owners and is taxed as personal income. Pass-through taxation is primarily used in the United States to tax sole proprietorships, partnerships, limited liability companies, and S corporations. Pass-through taxation has the advantage that with most small businesses the individual tax rates are lower than the corporate tax rates. This produces net savings on income taxes.
Advantage of Reduced Self-employment Tax
S corporations have special tax advantages, one of which is the ability to reduce your self-employment tax bill. This can result in a significant tax benefit, which is why many people incorporate. This is because with an S corporation your self-employment tax is only paid on what you pay yourself for salary, and not the profit of the business. However, you must pay yourself what is considered a reasonable salary.
Advantage of Personal Liability Protection
S corporations are companies that pay taxes through the individual tax system but offer the same limited liability protection as C corporations. An S corporation provides Personal Liability Protection, ensuring that you will not be personally liable for the company’s debts. Even in the event of corporate bankruptcy, your personal property, such as homes and cars, is protected from creditors, which is the main reason you should incorporate a business.
Advantage of Independent Lifespan
If you ever leave your company for any reason, including retirement or death, having an s corporation simplifies and speeds up the transfer. This is because s corporations are not tied to the owner’s life or involvement. It is easier to sell, or otherwise, transfer and grow an s corporation than are other types of businesses.
Disadvantage of Strict Requirements and Limitations
To qualify as an S corporation your business has several rules by which it must abide. You are limited to a single stock class. You cannot have more than a hundred owners. The owners must be paid a reasonable salary, which is derived from market conditions, and they must be paid regardless of profitability. This of course is also a motivation for keeping the number of owners as low as possible.
Disadvantage of Not Being Recognized in Every State
Unfortunately, some states and jurisdictions, such as Louisiana, do not recognize S corporation status. They will probably levy the same taxes and fees as they would any other corporation. The laws regarding S corporations vary significantly with your location. For example, the state of Texas recognizes S corporations, but still charges them the regular corporate franchise tax. Because of this, you need to check your local and state laws concerning S corporations.
Disadvantage of Corporate Rules and Protocol
S corporations have a lot of the same rules as any other corporation. They must keep minutes logs of meetings, have bylaws, hold to strict record-keeping, and file certain federal and state reports. In this regard, they are like all other corporations. If you do not have experience with corporate finance management it may be necessary to hire an experienced bookkeeper, accountant, or tax professional, to make sure you remain compliant with these rules.
Is an S Corporation Right for Your Business?
Deciding whether an S corporation is right for your business requires considering a lot of facts. This not only includes your local and state laws but whether it is worth it financially. If your business consists of you doing all the work, then it is probably not for you. But if you are hiring employees, and buying substantial assets such as vehicles and other equipment it could be the best way for you to go.
S corporations are a handy way of setting up a business. They have both tax and liability advantages. They are however not without their disadvantages. If your business is more than a solo operation on your part an S corporation may be the best business type for you.
Read more: What You Need to Know About Tax on Settlement Payments
