S Corporation Advantages and Disadvantages
- August 18th, 2014
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Between the different types of corporations and different kinds of partnerships that you could decide from when choosing a structure for your new business, there are certainly plenty of options to consider. But there are pros and cons to every type of business, and there are many S Corporation advantages and disadvantages that you need to know before you decide if that’s the right choice for you.
S Corporation Advantages
Being an S Corporation is an IRS designation, so there are obvious tax affects to this classification. Much like a partnership, an S Corp’s income gets passed down to its owners and shareholders, who report the income on their tax returns. Unlike the members of an LLC, who are subject to employment tax on the business’ entire net income, the only income that is subject to employment tax in an S Corp is the shareholding employee’s wage. The rest of the income is paid as a distribution, which, if taxed at all, is done so at a lower rate.
If shareholding employees incur expenses that are business related, they can often be written off as tax credits. However, it’s worth noting that if the employee owns 2% or more of the company in shares, certain benefits such as health and life insurances are considered taxable income.
An S Corporation is allowed to have an independent life, which separates it from its shareholders. This is a means of protecting the liabilities of the shareholders, so that if they choose to leave the company and sell their shares, they’re able to sever their ties with respect to their liability for the company’s actions. When a shareholder decides to leave and sell his/her shares, the company can continue operating without disruption.
S Corporation Disadvantages
In order to have the specific designation of an S Corp, there are additional operational procedures that need to be carried out. If your company is an S Corp, you have to have scheduled meetings with the company director and shareholders. You’re also required to ensure that someone takes a written record, or minutes, of those meetings. S Corporations also must maintain the records of the adoption of and updates to any by-laws, and for any stock transfers that occur.
S Corporations are required to pay their shareholding employees a reasonable wage, which means you can’t pay shareholders a low wage and then compensate with a higher distribution. If S Corps trying to pull one over on the IRS this way and are caught, it could be costly; in such an instance, the IRS may reclassify all of your distributions as wages, which would result in a significantly higher employment tax!
If you have more questions about S Corporation advantages and disadvantages, be sure to contact the tax professionals at JRH & Associates at (516) 794-5752!