The
biggest advantage of an S corporation over a partnership is that S corporation
shareholders would not be personally liable for corporate debts. In order to
receive this protection, it is important that the corporation be adequately
financed, that various formalities required by our state be observed (e.g.,
filing articles of incorporation, adopting by-laws, electing a board of
directors, and holding organizational meetings), and that the existence of the
corporation as a separate entity be maintained.
If you
expect that your business will incur losses in its early years, an S
corporation is preferable to a C corporation from a tax standpoint.
Shareholders in a C corporation generally get no tax benefit from such losses.
In contrast, as S corporation shareholders, you can deduct your percentage
share of these losses on your personal tax return to the extent of your basis
in the stock and in any loans you make to the entity. Losses that cannot be
deducted because they exceed your basis are carried forward and can be deducted
by you when there is sufficient basis.
Once
the corporation begins to earn profits, the income will be taxed directly to
you whether or not it is distributed. It will be reported on your individual
tax return and be aggregated with income from other sources.
Say
your business plan indicates that you plan to provide fringe benefits such as
health and life insurance. You should be aware that the costs of providing such
benefits to a 2% or more shareholder are deductible by
the entity but are taxable to the recipient. This treatment will apply to those
will own more than 2% of the entity.
However,
the S corporation could inadvertently lose its S status if any shareholder
transfers stock to an ineligible shareholder such as 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 and earnings could be subject to double
taxation—once at the corporate level and again when distributed to you. In
order to protect against this risk, we recommend that shareholders sign an
agreement promising not to make any transfers that would endanger the S
election.
We
hope you find this explanation helpful.
If you have questions, please do not hesitate to call our firm.