In this week’s edition of the Small Business Series we are discussing S-Corporations (S-Corp). You may be asking yourself, “What in the world is an S-Corporation?” In a nutshell, an S-Corporation is a corporation with 75 or fewer shareholders, that has elected and qualified for a special tax status with the IRS. To set up an S-Corp you do all of the same steps that you would take to set up a C-Corp. However, whenever it comes tax time you indicate on your tax forms that you want to be taxed as an S-Corp.
The biggest advantage of forming an S-Corp is tax related. Under an S-Corp structure the income passes through to the shareholders, therefore avoiding a perceived double taxation of a C-Corporation. As an S-Corp the corporate entity is separate from stockholders. Below is a list of some of the advantages and disadvantages with regards to S-Corps.
- The independent life of the corporation makes possible its continuation, and the relatively undisturbed continued operation of the business regardless of incapacity or death of one or more stockholders.
- Fractional ownership shares are easily accommodated in the IPO.
- With only a few exceptions, under the Subchapter S election for taxation as a partnership the S-Corp pays no income taxes on the corporation’s income, or loss, if passed through to the stockholders.
- To the extent the corporate shield is maintained and other investments and savings of the stockholders are not at risk, the personal life of stockholders is simplified.
- Access to credit and the ability to secure needed resources may be improved.
- Earnings are not subject to self-employment tax as long as stockholders-employees receive adequate compensations for labor and management of the business.
- Lenders may require personal guarantees from corporate officers as a condition of supplying credit, thus negating the limitation of liability.
- Restrictions of the sale of stock and/or buy-back agreements may prevent minority stockholders from being able to recover the value of their investment in the corporation.
- Stock ownership can become divided among many persons making it difficult to obtain a majority vote.
- Benefits paid to stockholder-employee may become costly and exceed the ability of the business to pay.