S Corp vs C Corp

An S corporation may be the most suitable form of business for a new venture. Here is an explanation of the reasons why. In many situations, the biggest advantage of an S corporation over a partnership is that as S corporation shareholders you would not be personally liable for corporate debts. In order to receive this protection, it is important that the corporation be adequately financed, that various formalities required by our state be observed (such as filing articles of incorporation, adopting by-laws, electing a board of directors, and holding organizational meetings), and that the existence of the corporation as a separate entity be maintained. Because you may expect that the business will incur losses in its early years, 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 shareholder can deduct their percentage share of these losses on their personal tax return to the extent of their basis in the stock and in any loans they make to the entity. Losses that cannot be deducted because they exceed your basis are carried forward and can be deducted by you when there is sufficient basis. Once the corporation begins to earn profits, the income will be taxed directly to you whether or not it is 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 will not be subject to self-employment tax, but your wages will be subject to social security and Medicare taxes. Your business plan may include that you provide fringe benefits such as health and life insurance. 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. This treatment would apply to you if each of you will own more than 2% of the entity. One thing to watch, the S corporation could inadvertently lose its S status if you transfer 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, I recommend that each shareholder sign an agreement promising not to make any transfers that would endanger the S election. S Corporation structure is definitely something to look into if you are setting up a new business. The potential tax savings along with the protection to shareholders from corporate debt give it several advantages to C Corporations and partnerships.