S corporations have certain tax advantages that you might consider for your small business. An S corporation is a regular corporation that has opted for the IRS Small Business Election to have all income or loss passed down to the personal tax returns of its shareholders rather than taxed at the corporate level. This avoids the dreaded double-taxation scenario – income first taxed at the corporate level and then taxed again as dividend income to the shareholders. Thus, S corporations provide the legal liability protection of a corporation, but have the tax characteristics of a partnership.
Flexibility with Compensation
S corporations also have unique flexibility on how shareholder-employees are compensated. For example, if more income is distributed as dividends and less as salaries, the corporation can potentially save on social security, Medicare, and unemployment taxes. However, certain rules govern how far you can go with this strategy, so understand the requirements to avoid problems. This article does not constitute legal or tax advice, and you should always consult a professional to help you make the best decisions for your own business.
Increased Opportunities for Deductions
Another S corporation advantage is that charitable deductions are not limited to 10% of income as they are with regular corporations. Also, S corporation shareholders can potentially deduct the company’s losses against other personal income.
Disadvantages of S Corporations
So, what’s the downside? S corporations can have only one class of stock and are limited to 100 shareholders. Shareholders cannot be partnerships, corporations, or nonresident foreigners. S corporations have a narrower range of tax-deductible fringe benefits available to their employees.
How to Elect S Corporation Status
If you are considering an S corporation election for the current calendar year, you have until March 15 to file IRS Form No. 2553 with the IRS. Newly formed standard C corporations have until the 15th day of the third month after incorporation to make the S corporation election.
The decision to become an S corporation is an important one. Don’t go it alone. Contact your CPA or income tax professional for specific tax information to determine if this is the right decision for your business. Then, when you’re ready to incorporate, partner with a reliable business formation service.