The principal advantage of an S corporation is that you avoid paying double taxes. In a traditional C corporation, profits are taxed at the corporate level, and they’re taxed again when paid to individual shareholders as dividends. In an S corporation, there are no taxes on earnings at the corporate level. Instead, profits or losses flow directly through to the shareholders. They pay taxes only once, when they report their share of earnings on their individual tax returns.
Another advantage: Doing business as an S corporation can be attractive in the early, unprofitable years of a start-up business. That’s because operating losses flow through your personal tax return, perhaps offsetting other taxable income. Losses are available to the extent of your basis in your stock plus loans directly from you to your corporation.
There are some trade-offs for these tax benefits, though. If you’re an owner-employee and own more than two percent of the company, you’ll receive less favorable tax treatment of some fringe benefits. There are also ownership limitations. The company can have only one class of stock, there can’t be more than 100 shareholders, and all of the shareholders must be U.S. citizens or residents.
Despite these drawbacks, doing business as an S corporation can still offer some tax planning advantages. If you can meet the ownership requirements, it might be well worth considering an S corporation election.
Contact our office for an in-depth analysis of the pros and cons for your company.