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The Vital Pros and Cons of an S Corporation

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Core Group

An S corporation is a type of corporation that meets the specified requirements of the Internal Revenue Code (IRS). An S corporation passes through most of its business income and loss to its shareholders like a sole proprietor. The owners are not liable to pay double tax, at the corporate level and then on the individual shareholder level. 

Advantages of S Corporation

Protection of assets

An S Corporation safeguards the personal assets of its shareholders and allows its co-owners to minimize personal liability. As a shareholder, you do not have personal liability for the business debts of the corporation. For example, if the company is unable to pay its debts, creditors can attach the business assets of the company while your assets like bank accounts or properties will remain protected. 

Tax-favorable categorization of income

You can draw a salary as an employee of S Corporation and can also gain dividends and other tax-free distributions, in conformity with your investment in the corporation. Distribution of dividends and salary can help the owner minimize self-employment tax liability while creating wages-paid deductions and other business expenses for the corporation. 

Pass-Through Taxation

Generally, an S corporation is not liable to pay federal taxes at the corporate level. Any income or loss is passed through to shareholders equally, who show it on their individual income tax returns. Business losses can counterbalance the income on the shareholder's tax returns to minimize the payment of income tax.  There are exceptions to this rule, for instance when the company was a C Corporation prior to electing S-Corporation status.

Disadvantages of an S Corporation

Ongoing Expenses

 To start an S corporation, you need to first form a legal entity for the business by fulfilling the basic initial requirements such as filing Articles of Incorporation with your desired state, acquiring a registered agent for the company and paying the applicable fees. You can have an LLC or corporation and elect S-Corporation status You may even have to pay franchise tax and annual report fees as some states also impose ongoing charges.

IRS Scrutiny 

The Internal Revenue Service (IRS) scrutinizes S Corporations to check the following issues:

  • Built-In Gains Tax(BIG): The BIG tax applies to the S corporations that converted from an existing C-Corporation. A BIG tax is triggered if assets of the corporation or distributions are made within five years after conversion.
  • Distributions: IRS scrutinizes the distributions made to the shareholders of the company in the form of salaries or dividends.  Employee shareholders must take a reasonable salary from the corporation for work performed.
  • Loan repayments: IRS checks all the documentation related to the loan to an employee shareholder and repayments.

Salary requirements 

The IRS guidelines suggest the following salary requirements for the salary of employees of S Corporation – The salary should commensurate with the duties and responsibilities, training and experience, dividend history, compensation agreements, payment to non-shareholder employees, and time and manner of paying bonuses to the prominent employees.

How to form an S Corporation

To form an S corporation, you need to file a Certificate of Incorporation with the state authorities and pay applicable fees and any other initial franchise taxes or related fees. After filing Articles of Incorporation, you need to file Form 2553 with the IRS to get S corporation status for your company. 

Your S Corporation must have an initial meeting of directors to adopt bylaws and initiate other corporate actions.

About Core Group

The Core Group has been rendering services over the past 20 years to help business owners improve financial systems, reduce taxes and understand the complications of business growth. Schedule a call to learn more about our services. 

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