Forming an S Corporation: Benefits and Drawbacks

forming an s corporation benefits and drawbacks

If you plan on forming a corporation, are you sure this is the best business entity for you? Start-ups often choose between forming a corporation or limited liability company. Usually, your choice will be based on the ease in forming the entity and how it will affect you tax-wise.

If you are an entrepreneur just starting out, incorporating your business can draw investor interest. However, forming an LLC can help you avoid double taxation, a noted reality if you establish a C corporation.

However, you can avoid double taxation – paying on your income and on stock dividends if you set up a Subchapter S corporation. Both an LLC and Subchapter-S will save you from double taxation, which can prove to be a burden to a start-up company.

forming an s corporation benefits and drawbacks

Pass-through Taxation

If you want to reduce your taxes, forming a Subchapter S or LLC will definitely help you save money in this area. In this instance, you can take advantage of pass-through taxation. 

Pass-through taxation  allows you to forego recording your taxes on your business tax return but, instead, allows you to add them to your personal return. 

Therefore, applying for Subchapter S status has certain undeniable benefits to new business owners as they can enjoy liability protection and only file their taxes once. However, if you want to go public with your company and receive more cooperation financially, you may still find forming a C corporation is more advantageous.

That’s because certain restrictions apply when you form a Subchapter S. For example, you can only have 75 shareholders on record.

S Corporation Shareholders 

According to Entrepreneur Magazine, S corporation shareholders may include individuals, some trusts, estates, certain types of partnerships, charitable organizations, and other S corporations acting as sole shareholders in your company. The magazine adds that federal law allows you to count you and your and your spouse as a single shareholder.

Setting Up Your Accounting System

When you set up an S corporation, you’re limited to using the accrual method of accounting versus the cash method. However, accrual accounting is much easier to set up. Your income is taxed when it’s received and your costs are deducted when they’re paid.

An S corporation  involves higher legal and accounting costs than an LLC. That’s because you still have to file articles of incorporation, maintain corporate minutes, hold board of director meetings, and give shareholders voting privileges. 

As a result, the accounting and legal costs are about the same as setting up a traditional C corporation. This may hamper you if you’re trying to raise business capital. Corporations must make an election for Subchapter S within 2 months and 15 days after the first day of the tax year and all the shareholders of record must consent to the election.

S Corporation vs LLC: How They’re Alike and How They Are Different

Both an S Corporation and LLC enjoy limited liability protection – someone cannot come after your personal assets, and both entities can take advantage of pass-through taxation. However, if you form an S Corporation, again, you’re limited to 75 shareholders while, as an LLC, you can have unlimited members. You can also include non-US citizens among your members if you create an LLC. 

Another C Corporation or S corporation, LLCs, partnerships and certain trusts cannot own an S Corporation. As an LLC, you’re not subject to these limitations. If you’re a C Corporation or S Corporation, the IRS outlines specific guidelines to follow and the proper forms to fill out on its website.

Before you do anything, you’ll need to obtain an employer identification number of EIN. This number, which is used for recording business taxes, can be likened to the social security number you use on your personal tax return. You’ll need an EIN to pay employees or to sign up for a business bank account.

Getting an EIN will keep your business activities separate from your personal financial account and will further safeguard your assets.

Forming an S Corporation: Establishing Your Business

To set up an S corporation, you should be willing to do the following:

  • Limit shareholders to U.S. based entities or individuals
  • Take part in  the formalities involved in running a corporation
  • Avoid the burden of double taxation
  • Take on the additional legal and financial costs of running an S Corporation
  • Wish to issue shares of stock, although limited to a common stock allocation. C Corporations may issue preferred stock to investors to receive capital funding

Who to Call about Setting Up your Subchapter S Corporation.

If you’re set on forming an S Corporation, you have it in your power to do so. As long as you understand the advantages and drawbacks, you’ll know what to expect. To get more details on the process, contact the authority for business incorporation today. Call the Corporation Center now at 800-580-4870 for further information.