What Is An S Corporation?
When you are deciding on the type of corporation for your company, there are many things to consider. The IRS recognizes two types of corporations you can choose from, a C Corporation or an S Corporation. An S Corp is a business structure that allows a business to avoid double-taxation. That is because an S Corp is not required to pay tax on its profits. Instead, all profits and losses are passed directly to the shareholders on their individual tax return. Those individuals will pay tax on their share of the profits only. This differs from a C Corp, which is viewed by the IRS as a legal entity in itself; therefore, it must pay tax on its profits through the company instead of the shareholder. Each business type has its own benefits and disadvantages, so you must decide based on your unique business which model will suit you best.
S Corporation Advantages
There are many great advantages to an S Corp that may outweigh any possible disadvantages. Perhaps the primary benefit one would receive through an S Corp structure is the tax savings for the shareholders as well as the business. Not only is there no corporate tax as was mentioned, but there is also the ability to reduce taxable gains. This is because the business losses can offset any other income on the individual’s tax returns. Shareholders providing services for the business are recognized as employees and should draw a salary, in addition to other distributions. This characterization of income can help reduce self-employment taxes and still continue to generate expense and wage deductions for the company. Also important to note, the individual assets of a shareholder of an S Corp may be protected. Unless there is an express personal guarantee, creditors cannot go after shareholder assets for company debt.
S Corporation Disadvantages
The formation of an S Corp may be a bit more involved than a sole proprietorship, and there are some ongoing expenses that occur. Articles of incorporation must be filed, a registered agent must be selected, and state fees must be paid before an S Corp is recognized. Depending on where the S Corp is located, there may be additional annual fees such as an annual report or franchise tax fees. Also, because of the significant tax benefits, the IRS will keep a closer eye on the financials. They will make sure any characterization of income is realistic, and may recharacterize dividends as wages which will cost the corporation and increase tax liabilities for the shareholders. Stock ownership is more tightly restricted, and the S Corp may issue only one class of stock. That means that investors cannot be segregated to receive different dividend amounts or distribution rights. There is a maximum of 100 shareholders, and foreign ownership is prohibited.
How to Choose Your Corporate Structure
Choosing a corporate structure involves many variables that are unique to your company or its goals. Depending on the type of business you plan to operate, the number of stakeholders or owners you have, and the financial situation you are in play a massive role in the best option to choose. Before selecting, you need to research and fully understand the different entity types and what they mean for your business. Consider the potential for any risks or liabilities as well as your needs for investors or cash flow. Find out the expenses and requirements, as well as the process for forming and continuing the company. Finally, you should know your tax situation exceptionally well, and understand how each corporate structure will affect them. It is wise to consult with an experienced and professional financial advisor or tax specialist as well as an attorney to receive sound advice and answers to your questions. It is important to understand that the type of structure you choose now does not mean you can never switch to an alternate structure. Do your due diligence, determine what works best now, and if the need arises, you can change the structure down the road.
Landwehr Financial Solutions Can Help
The staff at Landwehr Financial Solutions offer a broad range of services to assist you with financial concerns or questions including the type of corporation best suited for your business, and the tax implications of that choice. At Landwehr Financial Solutions, the particular needs of every client are met through our holistic approach. Contact us today for more information on the many services we offer our clients in the St. Cloud, MN area.