The S corporation (sometimes shortened to “S corp”) is one of the most often misunderstood business structures. Despite its perceived complexity, the S corp structure offers a unique set of benefits and limitations that make it the best choice for many entrepreneurs. Whether you are trying to start a new company or reform a pre-existing business, exploring the pros and cons of the S corp may reap significant benefits.

The basics

The S corporation is unique in that it has a limited ability to distribute stock, but is still eligible for “pass-through” taxation status (meaning that the profits of the company are only taxed as personal income). No other type of corporate structure offers this benefit.  As a result, an S corp benefits from the tax structure of more informal types of business, while retaining some of the ownership transfer ability offered by the C corp structure.

Like any form of incorporation, forming and maintaining an S corp can require substantial amounts of paperwork, some fees, and a great deal of administrative effort. S corps also offer the asset protection provided by all other forms of incorporation. This protection, combined with pass-through taxation status, makes the S corp a very interesting incorporation option for business owners.

Read ahead for a more in-depth look at the pros and cons of incorporating your business as an S corp.

Pros

Personal asset protection
Upon successful filing, an S corp becomes a completely separate legal entity from its individual owners and shareholders. This grants the business limited liability protection status, which means that in the event that the business can longer pay its debts, the personal assets of its shareholders cannot be collected as payment. Protection of assets is one of the most important factors in many business owners’ decision to incorporate.

Added credibility
The status of an S corp shows that your business has been vetted via the legal and regulatory processes of incorporation. This sends a positive message to potential clients or associates that your company is organized and is likely to be reliable. S corp status also shows potential creditors that the company can be trusted.

Relatively streamlined ownership transfers
While there are still some ownership restrictions placed on an S corp’s ownership structure, the actual transfer of said ownership is a much more streamlined process than in an LLCs or a partnership. This can provide a many financial benefits when selling interest in an S corp.

Tax benefits
The owners of an S corp can also be considered employees of the company. This creates favorable tax implications for two reasons: First, owners are able to greatly reduce their self-employment tax burden. In addition, they are also able to draw salaries and receive benefits as employees, which creates an expense (and less net profit), while still transferring funds to the owner.

Cons

Paperwork and fees
As with any corporate structure, S corps are required to complete a standard paperwork, submit to certain administrative formalities, and pay associated fees. S corps typically can’t avoid any of these requirements, and some smaller organizations might have a difficult time staying in compliance of these administrative regulations.

Ownership restrictions
Even though S corps center their ownership on stock distribution, there are some strict restrictions in place that limit who can purchase or hold shares in the company. An S corp’s ownership is limited to only 100 different individuals, who must be United States citizens. Other businesses and trust organizations are also restricted from becoming owners of an S corp.

Increased governmental observance
Because of the many financial benefits an S corp owner can reap, the IRS tends to keep a very close eye on all of the business’s major financial decisions. In the event of an audit, the IRS may force an S corp to reclassify many of their beneficial income distribution decisions.

Less income and loss allocation options
An S corp’s ownership is restricted to one class of stock, which can make it extremely difficult to distribute specific profits and losses to each individual owner. As a result, the owners of an S corp are typically forced to receive a portion of the company’s profits (or losses) in a very uniform manner. No other form of organization is faced with this restriction.  

Potential tax qualification issues
The unique set of requirements concerning the ownership and formation of an S corp creates an opportunity for errors during both the filing process as well as ongoing administrative processes. While uncommon, these errors may lead to the immediate dissolution of the organization.

Swyft can help!

If you have more questions about the S corp structure, contact the experienced professionals at Swyft. We’re here to help you navigate all of the different structures.We’ll help you find the ideal structure for your business!