S Corporations

It’s not difficult to form an S corporation: First you establish yourself as a C corporation with your state’s office of the secretary of state; then you file an additional Form 2553 with the IRS, which converts you to an S corporation. As an S corp, you no longer have to pay taxes twice: once on profits at the corporate level and again on dividends at the individual level. S corporation earnings flow through to your individual tax return. You’ll also be protected from personal liability by the well-defined precedents of corporate law. It’s also important to keep in mind that in 2018, pass-through entities will receive a 20% tax deduction due to the recent tax reform.

S corporations have a few disadvantages relative to traditional C corps, mostly in the limits imposed on shareholders: No more than 100 shareholders are allowed, and they cannot be foreigners or other corporations. Also, owners can create only one class of stock. Plus, there are some fairly complex shareholder compensation requirements. These focus on the classification of payouts as either “wages” or “distributions.” The SBA says that owners need to pay attention to “low salary/high distribution combinations” because these are red flags for the IRS.

Experienced attorneys say that the S corporation structure is not necessarily more expensive or complex to manage than an LLC. You’ll probably want to do an in-depth point-by-point comparison, guided by an expert, before choosing a business structure between these two. As noted above, the S corporation is probably the right choice for most small businesses, with the exception of those that will be pursuing a large number of shareholders or venture capital financing.