Note: A subchapter S corporation may only have U.S. citizen or resident shareholders.
Here is a checklist highlighting advantages and disadvantages of the S corporation form, as opposed to a C corporation. As you take a look please keep in mind that Congress may pass S corporation reform that would eliminate or lessen some of the current disadvantages. Just call us for an update.
Some of the advantages are:
- 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 (subject to what are known as the passive loss limits) can be a big advantage over regular corporations. Liquidating distributions generally also are subject to only one level of tax.
- The S corporation also has no corporate alternative minimum tax (AMT) liability (however, corporate items passed through to you may affect your individual AMT liability).
- Social security taxes are not payable 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.
- By paying salary to principals, you create an ability to contribute to 401(k) or SEP IRA plans, to the extent of 25% of salary paid. Although the salary is subject to social security tax, this allows for the deferral of up to $50,000 per person per year (for shareholders over age 50 – and $45,000 per year for those under 50 years of age.)
- 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.
Some of the disadvantages are:
- S corporations cannot have more than 35 shareholders (with husband and wife being considered as only one shareholder).
- Corporations, nonresident aliens, and most estates and trusts cannot be S corporation shareholders.
- S corporations may not own subsidiaries, which can make expansion difficult.
- 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 to shareholders.
- 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
- S corporations generally must operate on a calendar year.
Contact us to determine which option is right for you and your business.