Are you thinking about launching a business with some partners and wondering what type of business entity to form? An S corporation may be the most suitable form of business for your new venture. Here’s an explanation of the reasons why.
The biggest advantage of an S corporation business entity over a partnership is regarding shareholders. As a shareholder in this business structure, you won’t be personally liable for corporate debts.
In order to receive this protection, it’s important ensure adequate financing for the corporation. Maintain its separate entity status and follow state-required formalities. For instance:
Are you expect that the business will 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. Yet, as S corporation shareholders, deduct your share of losses on personal tax returns. You can deduct based on stock and loans to the entity. Excess losses beyond your basis are carried forward for future deduction when sufficient basis exists.
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. To the extent the income is passed through to you as qualified business income, you’ll be eligible to take the 20% pass-through deduction, subject to various limitations. Your share of the S corporation’s income won’t be subject to self-employment tax, but your wages will be subject to Social Security taxes.
Are you planning to provide fringe benefits such as health and life insurance? If so, 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.
Also be aware that the S corporation could inadvertently lose its S status if you or your partners transfers stock to an ineligible shareholder such as another corporation, a partnership or a nonresident alien. If the S election were terminated, the corporation would become a taxable entity. You would not be able to deduct any losses and earnings could be subject to double taxation — once at the corporate level and again when distributed to you. In order to protect you against this risk, it’s a good idea for each of you to sign an agreement promising not to make any transfers that would jeopardize the S election.
Consult with us before setting up a business entity. We can answer any questions you have and assist in launching your new venture.