The Advantages and Disadvantages of Forming an S Corporation

Published On October 12, 2017 | By Neva Occhipinti | Business

Most company owners are aware of the benefits of operating under a corporation. Although less popular compared to an LLC, many business owners still consider applying for the status of an S Corporation. While steps at the initial stages of forming an S-Corp are similar to C-Corp, the former necessitates the shareholders to file Form 2553 with the IRS and meet the criteria mentioned by the government. After getting the letter of approval from the IRS, the C Corporation gets the recognition of an S Corporation. As with everything, there are both advantages and disadvantages of forming an S-Corp which are discussed below.

Advantages of Forming an S Corporation

Among the various reasons to choose the option of registering a regular corporation as an S Corporation is to get relief from self-employment tax which is mandatory in case of an LLC. As a result, it constitutes a significant advantage of forming an S-Corp. Besides there is also another advantage – it eliminates the possibility of double taxation. The owners of a regular corporation or C Corporation are taxed for two times – corporation tax and distribution tax. When you combine both the advantages, it becomes clear that an S Corporation allows the shareholders to minimize the taxable amount significantly. If you earn over $118,500, you can still make a savings of around $20,000 or even more.

Apart from the two advantages mentioned above, it also simplifies matters when it comes to transferring the ownership of a company. While the transfer of more than 50% of the share of an LLC leads to the termination of the entire entity, the shareholders of S-Corp do not have such constraints. They can sell their part of the business without being worried about termination.

Disadvantages of Forming an S Corporation

While taking the advantages of forming an S-Corp into account, it is also important to consider its pitfalls or disadvantages. Going by the criteria for eligibility as set forth by the Government of the United States, an S-Corporation can only have 100 members, not more than that. Although the provision to have a maximum of 100 members seems to be adequate at the start of the company under normal circumstances, there can be a problem when you decide to go public with your idea of liquidation. It can create problems, especially when you seek to raise money via venture capitalists.

Another disadvantage of this type of corporation is the requirement to provide a reasonable salary. Other than raising ambiguity in terms of your salary as an employee or shareholder, it also necessitates basing the salary according to the job with similar requirements in the area. Thus, the idea of dealing with the IRS for getting relief from self-employment tax makes the idea less attractive.

Your best bet to form an S-Corp is to decide whether you have more than 100 shareholders or lesser than that. If you are sure about it, S Corporation would be the right way to go, as it would help you avoid double taxation and self-employment tax to help you save those precious dollars. However, if you have plans to go public to raise capital for your venture, adhering to a regular corporation would be a better idea. Whatever you choose, it is always helpful to consult an expert.

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