Should Your Small Business Become an S Corporation?

Pros and Cons of an S Corporation

Young S Corporation owner pitching a project in a penthouse executive boardroom to investors.
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Determining the type of company structure best for your small business can be a confusing exercise. Is an S Corporation advantageous for your small business? A little insight into the pros and cons of becoming an S Corporation may help in your decision-making process.

S Corporation

An S Corporation (Small Business Corporation) is a business elected for S Corporation Status through the IRS. This status allows the taxation of the company to be similar to a partnership or sole proprietor as opposed to paying taxes based on a corporate tax structure.

No Corporate Tax for S Corporations

The biggest attraction of this to a business owner may be the tax advantages. The profits and losses of the business pass through to the corporation owner's personal income tax. Like a Limited Liability Company, the tax "pass-through" allows you to avoid "double taxation". Unlike a non-corporate business structure, you avoid corporate taxes but will still have to file a tax return every year.

Reduced Taxable Gains

Selling your business can be part of your retirement strategy. An S corporation could have reduced taxable gains when the business is sold.

Ability to Write off Start-up Losses

In the early years of starting a business, you will have many expenses and losses. These can be offset against your personal income. A regular corporation would have the losses locked within the company and not applied to your income.

Offers Liability Protection

S corporations offer protection against liabilities. However, liability protection is not complete protection. You can be personally liable for your actions. In addition, many lenders are now requiring personal guarantees.

Limited to One Class of Stock

Choosing an S Corporation status will limit your organization to issuing one class of stock. Not having the ability to issue different classes of stock affords a business less control over the company and limitations on the stock value.

Less Attractive to Outside Investors

Growing your company requires money. If you will need venture capital, the regular corporation structure will be a better choice. Venture capitalists will not want to see the pass-through tax setup or a limit of 75 shareholders.

Required S Corporation Meetings

Your status is still a corporation with the requirements of having regular meetings and maintaining company minutes. Consider the added time in operating an S Corporation. Small businesses today are making the choice to form a Limited Liability Company (LLC) because they are easier to operate.

How to Form an S Corporation

Changing your corporation status requires the filing of Form 2553 with the IRS. To become a small business corporation, the IRS has several special requirements including:

  • The corporation can have no more than 75 shareholders with a husband and wife counting as one shareholder. (before 1997 it was 35 shareholders)
  • Shareholders can be individuals, estates, and certain trusts.
  • Shareholders cannot be non-American residents.
  • You must be a domestic company in any state.
  • All shareholders must agree to the S Corporation structure formation.

Deciding on the best business structure for your situation is never easy. This article should provide you with the basics of S Corporation status and help guide your decision of company business formation. Each state's laws differ as well as each company's situation. It's advisable to seek tax and legal counsel to determine the best choice for your individual circumstance.