Why Form an S Corporation?

written by Jacque Mattson

In August, we wrote about choosing a Partnership instead of an S Corporation (click here to read the article). In this article we will examine the advantages of an S Corporation and who may benefit from forming an S Corporation over a Partnership. There are various types of businesses one can form when starting a new company: Sole Proprietorship, Partnership, Corporation, S Corporation, and Limited Liability Company just to name a few. The type of entity you choose can have an effect on owner liability and taxes. An S Corporation has many different advantages that should be considered when trying to decide the formation of a company.

Owner Protection from Legal Liability

A major advantage of organizing your business has an S Corporation is that it protects the owner or owners personal assets from the creditors of the business. Owners have a limited amount of legal financial liability for the corporation's business activities and debts based upon the investment in the company because in the eyes of the law the corporation is a separate entity.

Tax Benefits

An S Corporation does not pay taxes at the business level. Similar to a Partnership, income and expenses are passed through to the shareholders based upon their ownership percentages, and the owners pay taxes depending upon their tax brackets. When it comes to the excess profits, dividends paid out to shareholders (also known as distributions) are normally not taxable or are taxed at a lower rate (if there are excess distributions over the shareholder's basis).

Self-Employment Tax Savings

One major difference of an S Corporation compared to a partnership is that a shareholder-employee can receive wages and save on self-employment tax. 100% of partnership earnings from a trade or business are subject to self-employment tax including the new Medicare tax on high-wage earners. S Corporation income is not subject to these taxes. If an owner is active in the S Corporation, wages should be paid to the owner. FICA and Medicare taxes withheld on those wages would partially offset the self-employment tax savings.

Stock and Stock Options

The S Corporation business structure offers an appealing opportunity to potential employees -- stock benefits and stock options. The S corporations’ ability to issue stock is also a strong selling point to those willing to invest capital in the business venture.

For more answers to your S Corporation questions, please feel free to give us a call at 417-881-0145.