Advantages and Disadvantages of S Corporations
Once you’ve made a decision to create a corporation for your business, there is still the choice of whether to form a C corporation or an S corporation. It’s important to look at the potential advantages and disadvantages of an S corporation before choosing this structure over a traditional corporation, or even an LLC or partnership.
Potential Advantages of an S Corporation
One of the biggest advantages of forming a corporation is the elimination of double taxation issues. With an S corporation, both profits and losses get passed on to the shareholders, and therefore, taxes are paid only once. Depending on the state you plan to operate in, S corporations may or may not be recognized, and could be taxed by the state as traditional C corporations, or some states may charge a state tax even though there is no federal tax being charged.
S corporation shareholders can work as employees and take their own salary. They can also receive distributions and dividends from the business that are tax free, up through the amount of their investment amount. Reasonable amounts for dividends and distributions can help provide a reduction in self-employment tax liability.
Another advantage is limited liability status with S corporations. Shareholders have protection against liability for the company’s liabilities and debts. Shareholders are only liable up to the amount is of their investment, and their personal assets are protected against the debts and liability of the business.
S corporations sell stock to raise capital and have an unlimited life, as ownership is defined by shareholders. In other words, it will continue to exist and remain in operation. The S corporation is not influenced by the death or departure of one individual director, owner, or founder.
Potential Disadvantages of an S Corporation
If you plan to do business in Washington D.C., note that the District does not recognize the federal S corporation status and there is no state-level S corporation election option. What this means is you can still have an S corporation, but it’s only an S corporation as far as federal taxes are concerned. For state taxes, the business will be treated like a traditional C corporation.
S corporations have strict restrictions on who can be a member. Members cannot be a non-US citizen, a corporation or another LLC. The strict membership is only a portion of the strict rules on S corporations. An S corp can’t have more than 100 shareholders and cannot issue more than one class of stock. Because there is only one class of stock, the business cannot allocate income or losses to certain shareholders, unlike an LLC that can allocate money however they set forth in their operating agreement.
The IRS pays closer attention to S corporations, especially because they can distribute dividends or a salary. The IRS wants to ensure the salary given to the shareholders is realistic and they aren’t just trying to reduce taxes.
Forming an S corporation takes a few extra steps versus a traditional C corporation. You start by filing for a traditional C corporation and then there are some additional requirements like annual reports and franchise tax fees in some states. S corporations are required to adopt a calendar year for taxes unless it can provide a valid reason it should be a fiscal year.
Washington DC Business Attorney
If you have questions on which business structure is right for you, it’s best to speak with a qualified Washington DC business attorney. The team at Tobin O’Connor & Ewing have years of experience helping businesses get started. Contact our office at 202-362-5900 to set up a consultation.