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  • Writer's pictureTimothy E. Brown, CPA

The Pros & Cons Of An S-Corp


An S-Corporation, or S-Corp, is a type of business structure in the United States that offers certain advantages and disadvantages. Here are some of the pros and cons of being an S-Corp:


Pros:


1. Limited Liability: Like other corporations, an S-Corp provides limited liability protection to its owners (shareholders). This means that shareholders are typically not personally responsible for the company's debts and liabilities.


2. Pass-through Taxation: One of the main advantages of an S-Corp is that it offers pass-through taxation. This means that the company's profits and losses are passed through to the shareholders, and the company itself does not pay federal income taxes. Instead, shareholders report their share of the company's income on their personal tax returns, potentially reducing their overall tax liability.


3. Tax Flexibility: Unlike a regular C-Corporation, S-Corps can avoid double taxation. Shareholders can pay themselves a salary, subject to payroll taxes, and receive additional income in the form of dividends, which are generally subject to lower tax rates.

4. Capital Structure and Ownership: S-Corps can have multiple classes of stock, allowing for different levels of ownership and capital structure. This can be beneficial for attracting investors and facilitating ownership transfers.


Cons:


1. Eligibility Requirements: S-Corps have certain eligibility requirements that must be met. For example, they cannot have more than 100 shareholders, and shareholders must be U.S. citizens or resident aliens. This can limit the flexibility and scalability of the business.


2. Stricter Formalities: S-Corps are required to follow stricter formalities compared to other business structures. They must hold regular shareholder and director meetings, maintain corporate minutes, and comply with other corporate governance requirements. Failing to meet these obligations can jeopardize the company's S-Corp status.

3. Payroll Taxes: While S-Corps offer tax advantages, they also require shareholders who are active in the business to pay themselves a reasonable salary, subject to payroll taxes such as Social Security and Medicare. This can result in higher employment tax obligations compared to other business structures.


4. Limited Ownership Structure: S-Corps cannot have more than one class of stock, meaning all shareholders must receive equal distributions based on their ownership percentage. This limitation can restrict the ability to offer different classes of shares and create complex ownership structures.


5. Potential Audit Risk: S-Corps are subject to a higher likelihood of being audited compared to sole proprietorships or partnerships. The IRS closely scrutinizes S-Corps to ensure that shareholders are paying themselves reasonable salaries and properly reporting income and deductions.


It's important to note that the pros and cons of being an S-Corp can vary depending on the specific circumstances of the business. It is advisable to consult with a qualified tax professional or attorney to evaluate the implications and determine whether an S-Corp is the right choice for your particular situation.

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