October 10, 2014
Is an S-Corp Structure Right for Your Business?
Choosing the right legal structure for your business involves careful consideration to find the best balance between liability protection, tax savings and the level of paperwork required by the IRS. This decision can be one of the most important ones made for a startup and may change as a business grows to accommodate different needs. The best way to evaluate all options, whether that includes a sole proprietorship, partnership, LLC or Corporation, is to get comprehensive advisement from knowledgeable legal advisors. For a quick look at the S-Corporation popular with entrepreneurs, here are some of the basic up-sides and down-sides.
The S-Corp allows owners to pass corporate profits, losses, deductions and credits to shareholders’ personal tax returns. This makes it possible to avoid double taxation (at the corporate and personal level), one of the major differentiators from a C-Corp.
While members of an LLC are subject to employment tax on the entire net income of the business, only the wages of S-Corp shareholders who are employees are subject to employment tax. The remainder is provided to the owner as a “distribution,” which is either taxed at a lower rate or not at all. But before lowering your salary to zero and classifying all earnings as a distribution to slash your tax bill, know that this comes with a caveat. Shareholders who work for the company must receive “reasonable compensation,” or the IRS may reclassify additional corporate earnings as wages. In some cases, the tax benefits of an S-Corp can also be combined with the legal advantages of an LLC.
At the state level, S-Corps are taxed in a variety of ways. Some states follow the federal government’s lead by taxing shareholders accordingly, some tax on profits over a certain threshold, and still others refuse to recognize the S-Corp structure altogether, taxing it like they would a C-Corp. instead.
Opportunity for Liability Protection
S-Corporations are “considered by law to be a unique entity, separate and apart from those who own it.” This separation limits the financial liabilities of owners and shareholders. It also makes it easy for the S-Corp to continue doing business without much disruption if a shareholder decides to leave the company or sell their shares.
A Longer Paper Trail
One of the significant downsides to the S-Corp is more rigid processes and paperwork. The IRS’ requirements include scheduled shareholder meetings, documentation from those meetings, and heavier records maintenance.
To see if your business qualifies as an S-Corp and whether it would benefit from this or another more favorable legal structure, consult with us today. Talley & Company has over 25 years of experience helping entrepreneurs successfully start and grow their businesses. From start-up to succession we maintain a proactive, tax efficient approach to our client’s business planning needs.