It is true that having an S corp has got many pros and cons at the same time. An S corporation is a small corporation which is taxed under Subchapter S of the Internal Revenue Code, which provides an electing corporation some, if not all of the tax advantages that are given to a partnership business. Here, an LLC will also be allowed to make an election, thereby allowing it to seek help of payroll tax savings which are discussed below. But before you start looking into the benefits and disadvantages of S corp, you need to know about a brief history on the Subchapter S corp.
Subchapter S Corporations were mainly created to bridge the gap between small and domestic corporations between corporate form which made sure that the members had no liability but had 2 different levels of taxation which offered a more efficient structure of tax which needed at least a single member to have liability exposure.
Benefits of Subchapter S which you should know
- A single level of tax: Much unlike a regular corporation which has to pay taxes on the income generated, there are no forms of double taxation in an S corporation. All the income and the losses are all handled over directly to the shareholders of the business.
- Save on payroll taxes: The shareholder of an S corporation who is engaged in the business of the corporation wears the hats of an owner and an employee. The corporation should pay social security and Medicare taxes on the employees for tax purposes. But distributions to shareholders aren’t subject to any kind of taxes. Hence, the more is the revenue that is obtained by the employee as a shareholder, the less Social Security taxes and the less Medicare you will need. As you may imagine that the IRS is scrutinizing the distribution of salary, thereby allocating very watchfully the required potential for exploiting.
The pitfalls of Subchapter S Corp
Once you start growing beyond a small business, you might find it tough to abide by the strict regime of Subchapter S corp. You need to be a domestic corporation, you can’t have more than 100 shareholders, you must have domestic individuals and qualifying trusts like shareholders and you also need to have a single class of stock. In case you fail to satisfy any such requirements, you’ll probably revert to the less favorable tax regime of a corporation.
How about opting for an LLC?
An LLC is perhaps the most versatile and tax effective business entity. Although a Subchapter S corporation offers similar kind of flow through tax treatment, an LLC is better wherever much debt is involved and hence it is extremely flexible with no such restrictions on equity classes or shareholders.So, why not form an LLC? Is it due to the expensive factor of forming it? An LLC operating agreement can sometimes be a bit too complicated and hence this is one of the reasons which make people avoid the chances of forming an LLC.
Therefore, if you’re still confused about whether to start an S corp or an LLC, make sure you know the details of both before taking the final decision.