- Find out why choosing an S corporation could be the best choice for your venture.
- Learn how an S corporation could help you if you anticipate losses.
- Discover the consequences of losing your S corporation status and how to prevent losing it.
Thinking about launching a business with some partners and wondering what type of entity to form? An S corporation may be the most suitable form of business for your new venture. Here’s Fiducial’s explanation of the reasons why.
The biggest advantage of an S corporation 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 the corporation be adequately financed, that the existence of the corporation as a separate entity be maintained, and that 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).
Do you expect that the business will incur losses in its early years? Then, from a tax standpoint, you should choose an S corporation over a C corporation. 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 these losses on your personal tax returns to the extent of your basis in the stock and in any loans you make to the entity. Losses that you can’t deduct because they exceed your basis carry forward and can be deducted by you when you have 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. To the extent the income passes through to you as qualified business income, you’ll meet eligibility requirements 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 know that the costs of providing such benefits to a more than 2% shareholder are deductible by the entity. However, they are taxable to the recipient.
Be careful with S corporation status
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 shareholders include 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. Additionally, 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 your Fiducial representative before finalizing your choice of entity. We can answer any questions you have and assist in launching your new venture. Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations to discuss your situation.
For more small business COVID-19 resources, visit Fiducial’s Coronavirus Update Center to find information on SBA loans, tax updates, the Paycheck Protection Program, paid sick and family leave, and more.