Starting a business with partners and not sure which entity to choose? An S corporation could be the perfect fit for your new venture.
One benefit of an S corporation
One big perk of an S corporation is that shareholders aren’t personally liable for the company’s debts. To keep that protection intact, make sure you:
- Properly fund the corporation
- Keep it separate from personal finances
- Follow state requirements (like filing articles of incorporation, adopting bylaws, electing a board of directors, and holding organizational meetings).
Handling losses
If you expect early losses, an S corporation offers a better tax advantage than a C corporation.
While C corp shareholders don’t get tax benefits from losses, S corp shareholders can deduct their share of losses on personal tax returns—up to the amount they’ve invested in the business. Losses that exceed your basis can be carried forward to offset future profits when there’s sufficient basis.
Profits and taxes
Once the S corporation starts earning profits, the income is taxed directly to you, regardless of whether it’s distributed. This income is reported on your personal tax return and combined with your other earnings.
Your share of the S corporation’s income isn’t hit with self-employment tax, but your wages are subject to Social Security taxes. If the income qualifies as qualified business income (QBI), you can take a 20% pass-through deduction, subject to certain limitations.
Note: The QBI deduction is set to expire after 2025 unless Congress extends it. However, there’s a good chance it will be extended—and possibly even made permanent—under ongoing Tax Cuts and Jobs Act negotiations.
Fringe benefits
If you’re offering fringe benefits like health and life insurance, keep in mind that while the company can deduct the cost for shareholders owning more than 2%, the benefits will be taxable to the recipient.
Protecting S status
Be careful about transferring stock to ineligible shareholders (like another corporation, a partnership or a nonresident alien), as it could terminate your S election, turning the corporation into a taxable entity.
To avoid this risk, have shareholders sign an agreement to prevent transfers that would jeopardize the S status. Also, remember that an S corporation can’t have more than 100 shareholders.
Final steps
Before settling on your business entity, reach out to your Smolin advisor to discuss your options. We’re here to answer your questions and help set your new venture up for success.