Understanding the S-Corporation
Choosing the right business structure is a key decision. It affects your taxes, personal liability, and how your company operates and grows.
An S-Corporation (S-Corp) is a type of business entity that offers two major benefits: liability protection and pass-through taxation. This structure allows profits and losses to flow through to the owners’ personal tax returns, avoiding the double taxation faced by traditional C-Corporations.
Key Benefits of an S-Corp
1. Pass-Through Taxation
With an S-Corp, the business doesn’t pay federal income taxes. Instead, profits and losses “pass through” to the shareholders, who report them on their personal tax returns. This helps avoid corporate-level taxation.
2. Limited Liability
S-Corps protect the personal assets of their owners. Shareholders generally aren’t personally responsible for business debts and obligations.
3. Easier Ownership Transfers
Ownership in an S-Corp can be transferred easily by selling stock. This makes it simpler to bring in new partners or pass the business to heirs.
4. Potential Tax Savings
S-Corp owners can save on self-employment taxes. They may also deduct certain expenses, such as health insurance premiums, depending on how they structure their compensation.
Potential Drawbacks of an S-Corp
1. Payroll Requirements
Shareholders who work for the business must be paid a salary. This creates more payroll compliance, including withholding taxes and filing regular payroll returns.
2. Limitations on Loss Deductions
Shareholders can only deduct business losses if they have “basis” in the company—meaning money invested or retained earnings. Losses generally can’t be claimed based on borrowed funds, unlike in some partnerships.
3. Equal Distributions
Distributions must be made based on ownership percentage. If one shareholder receives a payout, all must receive one in proportion to their shares.
4. Ownership Restrictions
S-Corps have strict ownership rules. They can’t have more than 100 shareholders, and all must be U.S. citizens or residents. Foreign ownership is not allowed.
Is an S-Corp Right for You?
S-Corps offer several advantages—but they’re not for every business. Here are some important factors to consider:
Business Size and Goals
S-Corps are ideal for small businesses that don’t plan to go public. If you’re aiming for fast growth or venture funding, a C-Corp may be a better fit.
Eligibility Requirements
Not every business qualifies. You must meet strict IRS rules, including the 100-shareholder limit and U.S. residency for all shareholders.
Tax Strategy
While pass-through taxation can save money, that’s not always the case. A tax advisor can help determine if an S-Corp minimizes your overall tax liability.
Administrative Complexity
S-Corps must follow corporate formalities—like holding annual meetings and keeping proper records. Be prepared for the added administrative work.
Attracting Investors
If raising money is a top priority, know that many investors prefer structures like C-Corps, which offer more flexibility in stock classes and ownership.
Let’s Find the Best Fit for Your Business
Choosing the right entity is about more than taxes—it’s about setting your business up for long-term success. An S-Corp can be a powerful tool, but only if it aligns with your goals and circumstances.
Book a consultation with our team to explore your options. We’ll help you make an informed decision with confidence.
Joy Lutz, CPA, CTP
As the founder of Aligned CPA, Joy has built a firm that is your strategic financial partner. With a growth centric approach, we build meaningful relationships with our clients because we value their success as much as our own.
Positioning ourselves as the tax and financial strategists for your business, we help you make empowered, financial-based business decisions that lead to long term success.