Advantages and Disadvantages of S Corporations

An S Corporation is initially formed in the same manner as a C Corporation, by filing incorporation documents with the state of incorporation. Once the business has incorporated, the owners may decide to file as an S Corporation, within approximately 75 days of incorporating. To do so, they need to file an IRS Form 2553. This does not create a separate type of corporation, but does change the corporation's tax structure.

The S Corporation has shareholders and is taxed like a sole proprietorship or a partnership rather than like a C Corporation, which is taxed as a separate business entity. Income is passed through to the shareholders, who report their pro rata income, or losses, on their individual tax returns. The corporation still files a federal tax return (Form 1120S) and possibly a state return as well, if required by individual state law. The S Corporation shows profits and losses as they pass through to the shareholders, and the corporation does not pay federal income tax as a separate entity. Some states, however, do tax S Corporations in the same manner as C Corporations. Check your state tax laws before electing S Corporation status.

Advantages of an S Corporation

• Corporate losses can be passed through to the shareholders, and as the owner (and shareholder), you may be able to take the loss against income that appears on your personal return.
• You can have the protection of limited personal liability without having to pay corporate taxes.
• You can minimize self-employment tax and FICA tax. Your profits, as a shareholder, are not taxed in this manner.
• It's easier to raise capital as a corporation than as a sole proprietorship or partnership.