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Pros and Cons of an S-Corporation (S-Corp) for Small Business

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Among the multiple business structures the Limited Liability Company and the S-Corporation are two of the most popular, but is it worth it to elect for S-Corporation treatment for tax purposes?  Contrary to popular belief an S-Corp is not an entity that is set up like an LLC or Corporation, rather it is a tax designation that owners of LLCs or Corporations may elect.  Electing for your business to be treated as an S-Corp for tax purposes allows gains and losses of the business to flow through the corporate entity to the business owners who report the gains and losses on their individual tax returns.

Before your company can be designated as an S-Corp, however, you must ensure that it meets the four requirements of an S-Corporation. First, the corporation or LLC must be a domestic entity. Second, the corporation must be owned only by “allowable shareholders.” You may not elect your business for S-Corp treatment if it is owned by another corporation, a partnership, or nonresident aliens. Third, the corporation must not have more than 100 shareholders.  Fourth, there must be only one class of stock issued. After ensuring your business meets these requirements you may elect for S-Corp designation. 

Before deciding whether to elect for S-Corp treatment Consider the following pros and cons of an S-Corporation:

Pros:

  • S-Corps act as a Tax Flow-through – gains and losses incurred by the S-Corp are not taxed at the corporate level but instead flow through to the S-Corp’s owners who report the gains and losses on their individual tax returns.
  • Personal Asset Protection – Like other types of business organizations, S-Corps protect their owners from personal liability. This means that owners of the S-Corp will not be held personally liable for the business’s debts or judgments against the business despite the fact that an S-Corp is a flow-through tax entity. S-Corp owner’s personal assets will remain safe provided the S-Corp is operated as a separate entity (for tips on how to avoid piercing of the corporate veil click here).  However, liability protection is not 100% guaranteed.  Check out our blog post and video titled “4 Simple Steps to Protect Your Business from Piercing of the Corporate Veil” for more information on how to protect your personal assets from business creditors and liabilities. 
  • Characterization of Income from an S-Corp – The main benefit an S-Corp offers its owners is the ability of the owners to designate income from the S-Corp as salary or distributions.  Owners of an S-Corp may draw a salary from the S-Corp and distribute remaining profits to the owners. The portion of the income that is designated as salary will be subject to Social Security and Medicaid taxes, but the portion that has been designated as profit distribution avoids these extra taxes.  As long as the salary is reasonable and within proper parameters, S-Corp owners can save large amounts of money by avoiding Social Security and Medicaid taxes.
  • Out-of-Pocket Reimbursement – In situations where business expenses are not tax deductible, S-Corp owners may choose to be reimbursed for their business expenses (such as travel, business cellular plans, or office rental) by the S-Corp.  This may be accomplished by establishing an account payable plan by which out-of-pocket business expenses may be handled

Cons:

  • Recurring Expenses – S-corps require additional accounting work for payroll taxes which may result in additional fees to the owner.  However, the tax benefits often far exceed the additional costs. 
  • Limitations on Shareholders – As briefly mentioned above, an S-Corp may only be owned by individual shareholders or members (corporations, partnerships, and nonresident aliens may NOT be shareholders of an S-Corp).  Further, the S-Corp may have no more than 100 shareholders and may issue only one class of stock.
  • IRS Scrutiny – Because owners of the S-Corp can choose to designate part of their income derived from the S-Corp as either salary or dispersions, the IRS will more closely analyze your income designations to ensure that they align with reality and your salary is reasonable in light of the dispersion you collect.  Because of this it is important to make sure you sure you draw a reasonable salary (not questionably low).

Before deciding to elect for S-Corp designation for tax purposes be sure to consult with your tax and legal advisors to ensure you are making the correct decision.

If you are starting a new business and not sure where to start, check out our video and blog post entitled: 6 Key Steps to Starting a Business

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  • Being a first time business owner, you want to make sure you're making all the right decisions. Choosing McCormick Law & Consulting, along with Emma and Taylor, made the process so easy! Emma understood right away what my primary concerns were, and was able to execute everything in a very timely manner! She was extremely easy to talk to and she took the time to explain everything to me, settling my nerves with taking this next big step. Taylor made the process of making it all official completely stress free.
    Crystal G.
  • I am a criminal defense attorney licensed in both North Carolina and Virginia. I have taught attorneys across the State of North Carolina on varying trial matters ranging from jury selection to DWI defense. I definitely could have created my new business, Davis Wealth Management LLC, but boy that would have been a mistake. Because business formation is not an area in which I practice, I had no idea where my blind spots were, and let me tell you there were plenty. The knowledge I received from the firm is invaluable.

    John McCormick and his firm are very reasonably priced and quickly and efficiently assisted me in creating my new business. It was completely turn key; they did everything for me.

    I can't recommend their services enough. Also, huge shoutout to Taylor who kept me informed every step of the way!

    James D.
  • I highly recommendMcCormick Law & Consulting! My Father and I live in two separate states and the properties he needed legal services for are in Virginia. I reach out to Taylor on two separate occasions and she was very responsive and professional. The first time we used their services it went so smoothly that by the time I needed their services again I knew I could just send over the necessary documents, pay my invoice and rest assured it would all get taken care of. They eliminated the stress that comes with handling some else's affairs and I so appreciate that.
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  • I had the good fortune of working with McCormick Law on a business sales contract. I sent them the initial draft provided by the buyer along with a few notes about my specific concerns. They carefully went through the document and provided meaningful additions and corrections that better protected my interests. Thanks to Bobby and John for their personalized attention.
    Arthur B.
  • Mr. McCormick and his entire team were amazing! They assisted me in a legal matter concerning a business dispute. Mr. McCormick is highly experienced, ethical, dedicated, and was prepared to fight my legal matter in court if necessary. I thank the entire team for believing in me and would highly recommend them to anyone!!
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  • We used McCormick Law to start up another LLC and it was a great experience. I have used other lawyers and attorneys in the past and I experienced delayed responses and it was what I have come to expect.From the first interactions with Robert and his team, I was surprised to how responsive they were. I even mentioned to my new business partner that this was not normal and I was very happy.Needless to say I will be using McCormick Law for all of my business needs in the future.
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    McCormick Law, PC d/b/a McCormick Law & Consulting is a boutique business and real estate law firm located in Norfolk, Virginia & Raleigh, North Carolina, that seamlessly serves clients throughout Virginia and North Carolina. Whether you are a new or existing client of the firm, McCormick Law, PC, cannot represent you on any new matter until the firm has made a determination that there is no conflict of interest and that it is willing to accept the new engagement. The testimonials on this website reflect the real-life experiences and opinions of our clients. However, the experiences are personal to those particular clients, and may not necessarily be representative of all clients. We do not claim, and you should not assume, that all clients will have the same experience. Your outcome may vary.

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