Choosing An Entity For Your Business? How About An S Corporation?

selecting an s corporation as the best business structureAre you starting a business with some partners and wondering what type of business entity to form? If yes, an S corporation may be the best business structure for your new venture. Here are some of the reasons why.

One reason why an S corporation might be the best business structure over a partnership is that as S corporation shareholders, you won’t be personally liable for corporate debts. In order to receive this protection, it’s important that:

  • You are adequately financing the corporation.
  • You are maintaining the existence of the corporation as a separate entity.
  • Various formalities required by your state be observed.
    For example, filing articles of incorporation, adopting by-laws, electing a board of directors and holding organizational meetings.

Dealing With Losses

Are you expecting the business to incur losses in its early years? If yes, an S corporation is preferable to a C corporation from a tax standpoint. Shareholders in a C corporation generally get no tax benefit from such losses. In contrast, as S corporation shareholders, each of you can deduct your percentage share of losses on your personal tax return. This deduction is applicable to:

  • The extent of your basis in the stock.
  • In any loans you made to the entity.

Losses that can’t be deducted because they exceed your basis are carried forward and can be deducted by you in the future when there’s sufficient basis.

Once the S corporation begins to earn profits, the income will be taxed directly to you whether or not it’s distributed. It will be reported on your individual tax return and be aggregated with income from other sources. Your share of the S corporation’s income won’t be subject to self-employment tax. However, your wages will be subject to Social Security taxes. To the extent the income is passed through to you as qualified business income (QBI), you’ll be eligible to take the 20% pass-through deduction, subject to various limitations.

Note: Unless Congress acts to extend it, the QBI deduction will be expiring after 2025.

Are you planning to provide fringe benefits, such as health and life insurance? If yes, you should be aware that the costs of providing such benefits to a more than 2% shareholder are deductible by the entity but are taxable to the recipient.

Protecting S Status

Also be aware that the S corporation could inadvertently lose its S status if you or your partners transfer stock to an ineligible shareholder such as:

  • Another corporation.
  • A partnership.
  • Or a nonresident alien.

For termination of the S election, the corporation would become a taxable entity. You would not be able to deduct any losses and earnings could be subject to double taxation. Double taxation would be once at the corporate level and again when distributed to you. In order to protect against this risk, it’s a good idea for each shareholder to sign an agreement promising not to make any transfers that would jeopardize the S election.

For the best business structure for your new venture, consult with us. As a small business accounting company, we can answer any questions you have and assist in launching your new venture.