S Corporation Advantages and Disadvantages (2024 Update)

S corporation advantages: pass-through taxation, limited liability protection, and credibility

No federal taxes at the corporate level

An S corporation is a special type of business entity that offers certain tax benefits. One of the key advantages of an S corp is that it doesn’t have to pay federal income taxes at the corporate level. Instead, the company’s shareholders pay taxes on their share of the company’s profits. This can save the company significant amounts of money in taxes each year.

Additionally, pass-through taxation is a key feature of S corporations. Being taxed as pass-through entities means the business itself is not subject to corporate income tax. The profits, losses, deductions, and credits of the business are flowed through to the shareholders, who report them on their individual tax returns.

Lower self-employment tax (FICA payrolls withhold tax)

In Delaware, self-employed individuals are required to file and pay federal self-employment taxes, which include the Social Security tax and the Medicare tax.

According to the IRS, tthe tax rate stands at 15.3% for all self-employment income, which consists of 12.4% for Social Security (e.g., old-age, survivors, and disability insurance) and 2.9% for Medicare(e.g., hospital insurance).

You are required to pay self-employment tax if your net earnings from self-employment surpass $400, or if you received at least $108.28 in church income.

One of the key benefits of an S corporation is its potential to reduce your self-employment tax liability. If you are the sole proprietor of a business, you typically have to pay both income taxes and self-employment taxes on your business profits.

However, with an S corporation, you have the option to only pay Social Security and Medicare taxes on the salary you take from the business, rather than on the business profits themselves (which are only subject to income tax).

High level of asset protection

S corporation can offer some liability protections for your personal assets. If your business is sued or incurs debts that it cannot pay your personal assets will not be at risk if they are held in the S corporation. This can provide peace of mind and some financial security in case of legal or financial trouble for your business.

Perpetual existence

S corps have perpetual existence, meaning that they exist indefinitely. This is one of the advantages of S corp over a limited liability company, which dissolves upon the death of its members. If you want to create a business that will last beyond your lifetime, an S corp may be the best structure.

Flexible accounting methods

S corporations allow business owners to choose how to account for their income and expenses, which can provide them with enhanced flexibility. This flexibility allows s corporation shareholders to use the accounting method that results in the lowest taxable income. For example, S corporation shareholders who have inventory can elect to use the cash method of accounting, which does not require the recognition of inventory until it is sold.

Ease of ownership transfer

S corp shareholders can transfer their ownership interests much more easily than the owners of C corps or other business entities. Shareholders can transfer their shares to another corporation without having to go through a lengthy and expensive process.

Enhanced credibility

One of the main advantages of setting up a business as an S corporation is enhanced credibility. When you are an S corporation, it shows potential customers and clients that you are a serious and legitimate business. This can help you to win over new customers and clients, as well as keep the ones that you already have.

Similarly, the ability to raise capital is one of S corp advantages that comes with this business structure. If you are looking to expand your business or take it to the next level, then you will need to raise capital. When you are an S corporation, it is easier to attract investors and get loans from banks. This is because S corporations are seen as being more stable and less risky than other types of businesses.

S corporation disadvantages: complicated obligations and stock-related restrictions

More corporate formalities and tax obligations

One of the biggest S corporation’s disadvantages is that it is subject to more stringent regulations than other business entities. Evidentially, S corporations must file annual Income tax returns (Form 1120-S); if applicable the quarterly federal tax returns for employers (Form 941) and keep detailed records of their financial activities. Additionally, S corporations can only have a limited number of shareholders, which may limit their growth potential. You may want to consider compliance requirements as an S corporate here

Stock ownership restriction

S corporations are subject to certain restrictions on ownership, which may impact the decision of whether to form an S corporation.

• The number of shareholders is limited
  S corporations can have no more than 100 shareholders, and all shareholders must be U.S. citizens or resident aliens. This can be a disadvantage if the business needs to raise capital by selling equity to investors.
• All shareholders must consent to the election of S corporation status
  If even one shareholder does not agree to the S corporation election, the business will not be able to qualify for this corporate structure.
• S corporations are not allowed to have certain types of shareholders
  Those shareholders are non-resident aliens, partnerships, corporations, or other S corporations. This limits the potential pool of shareholders that an S corporation can have.

Increased level of scrutiny from the IRS

S corporation is subject to more scrutiny from the IRS, especially on the balance of salary payments versus dividends. In an S corporation, the IRS is looking for a reasonable salary. If the shareholders of an S corporation are also employees, they must pay themselves a reasonable salary.

Conclusion

To sum up, S corporation has perpetual existence, limited liability protection, and pass-through taxation. Yet, choosing S corp status also has strict requirements, such as the number of shareholders, only one class of stock, and US citizenship. There are also limits on who can be a shareholder and other S corporation advantages and disadvantages that you may now be aware of.

Feel free to chat with our consultants if you have more questions about US business structures or where to start your business in the US.

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