S Corp Status for Small Business: Tax Pros and Cons

If you’re trying to decide how to structure your small business, you may be looking at an S corp. Usually, you’d be considering either a C corporation or an S corporation and be weighing the benefits of both. While tax concerns tend to play the biggest role in this decision, there are other aspects to consider as well. Below you will find the pros and cons of an S corp status for small businesses.

Pros of an S corp status for small businesses

● Retained earnings: shareholders are not subject to double taxation.

● Transfer: Shares can be transferred with ease

● Income and loss statements: these as well as capital losses, are allocated pro rata on a daily basis to each shareholder based on their ownership of all the shares.

● Pass-through income: isn’t considered self-employed income, an S corp isn’t subject to Social Security or Medicare taxes.

● Health care premium deductions: Those who own more than 2% can deduct 100% of health care premiums under a plan established by the corporation

● No tax on distributive allocation: When an S corp pays its shareholders a reasonable salary, they will only be taxed for Social Security and Medicare

● Section 199A: S crops are eligible for 20% Section 199A deduction for qualified business income (except where not allowed by law)

● Unlimited life: The corporation can have an unlimited life

● Maximum protection: As long as shareholders keep their business and personal separate, they get maximum protection for their personal assets.

● No Net Investment Income Tax

● Fringe benefits: Not considered income for shareholder or employee who owns less than 2%

Cons of S corp status for small businesses

● Maximum of 100 shareholders

● Nonresident aliens cannot be shareholders

● Shareholders must be individuals (or certain trusts)

● Shareholder limitations: Multi-member LLCs, C corporations, and partnerships cannot be shareholders

● Pension plan startup costs credit: Cannot be claimed if there are more than 100 employees earning over $5,000 in the prior year

● One class of stock: Only allowed to have one class of stock (most cases)

● State tax laws: Some may not recognize an S corp

● Limitations exist: On some deductions that are generally itemized deductions of shareholders

● Deductions for health insurance: Not allowed to exceed the earned income of the owner-employee

● No debt to outside parties: A shareholder can’t include debt in their basis of entity when it comes to debt to outside parties

● Subject to tax: Shareholders may be subject to tax on income related to their investments in the corporation

● Section 1244: Restrictions exist on the ordinary income treatment on Section 1244 qualified small business stock

● Fringe benefits: If an owner-employee owns more than 2% in stock, they may have to include fringe benefits in their gross income

● Distributions: to shareholders may be taxable if they exceed the AAA account first, earning and profits second, and the remaining basis in stock third.

● Must use a calendar year: For profit and loss reporting S corps must use a calendar year, unless they apply and are granted to use a fiscal year from the IRS.

● Proportionate allocation and distribution: Must make proportionate allocation and distribution based on ownership interest