𝐈𝐬 𝐀𝐧 𝐒 𝐂𝐨𝐫𝐩𝐨𝐫𝐚𝐭𝐢𝐨𝐧 𝐓𝐡𝐞 𝐁𝐞𝐬𝐭 𝐂𝐡𝐨𝐢𝐜𝐞 𝐎𝐟 𝐄𝐧𝐭𝐢𝐭𝐲 𝐅𝐨𝐫 𝐘𝐨𝐮𝐫 𝐁𝐮𝐬𝐢𝐧𝐞𝐬𝐬?
Are you thinking about launching a business with some partners and wondering what type of entity to form? An S corporation may be the most suitable form of business for your new venture. Here’s an explanation of the reasons why.
𝐓𝐡𝐞 𝐛𝐢𝐠𝐠𝐞𝐬𝐭 𝐚𝐝𝐯𝐚𝐧𝐭𝐚𝐠𝐞 𝐨𝐟 𝐚𝐧 𝐒 𝐜𝐨𝐫𝐩𝐨𝐫𝐚𝐭𝐢𝐨𝐧 𝐨𝐯𝐞𝐫 𝐚 𝐩𝐚𝐫𝐭𝐧𝐞𝐫𝐬𝐡𝐢𝐩 𝐢𝐬 𝐭𝐡𝐚𝐭 𝐚𝐬 𝐒 𝐜𝐨𝐫𝐩𝐨𝐫𝐚𝐭𝐢𝐨𝐧 𝐬𝐡𝐚𝐫𝐞𝐡𝐨𝐥𝐝𝐞𝐫𝐬, 𝐲𝐨𝐮 𝐰𝐨𝐧’𝐭 𝐛𝐞 𝐩𝐞𝐫𝐬𝐨𝐧𝐚𝐥𝐥𝐲 𝐥𝐢𝐚𝐛𝐥𝐞 𝐟𝐨𝐫 𝐜𝐨𝐫𝐩𝐨𝐫𝐚𝐭𝐞 𝐝𝐞𝐛𝐭𝐬. In order to receive this protection, it’s important that the corporation be adequately financed, that the existence of the corporation as a separate entity be maintained and that various formalities required by your state be observed (for example, filing articles of incorporation, adopting by-laws, electing a board of directors and holding organizational meetings).
𝐈𝐟 𝐲𝐨𝐮 𝐞𝐱𝐩𝐞𝐜𝐭 𝐭𝐡𝐚𝐭 𝐭𝐡𝐞 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, each of you can deduct your percentage share of these losses on your personal tax returns to the extent of your basis in the stock and in any loans you make to the entity. Losses that can’t be deducted because they exceed your basis are carried forward and can be deducted by you when there’s sufficient basis.
𝐎𝐧𝐜𝐞 𝐭𝐡𝐞 𝐒 𝐜𝐨𝐫𝐩𝐨𝐫𝐚𝐭𝐢𝐨𝐧 𝐛𝐞𝐠𝐢𝐧𝐬 𝐭𝐨 𝐞𝐚𝐫𝐧 𝐩𝐫𝐨𝐟𝐢𝐭𝐬, 𝐭𝐡𝐞 𝐢𝐧𝐜𝐨𝐦𝐞 𝐰𝐢𝐥𝐥 𝐛𝐞 𝐭𝐚𝐱𝐞𝐝 𝐝𝐢𝐫𝐞𝐜𝐭𝐥𝐲 𝐭𝐨 𝐲𝐨𝐮 𝐰𝐡𝐞𝐭𝐡𝐞𝐫 𝐨𝐫 𝐧𝐨𝐭 𝐢𝐭’𝐬 𝐝𝐢𝐬𝐭𝐫𝐢𝐛𝐮𝐭𝐞𝐝. It will be reported on your individual tax return and be aggregated with income from other sources. To the extent the income is passed through to you as qualified business income, you’ll be eligible to take the 20% pass-through deduction, subject to various limitations. Your share of the S corporation’s income won’t be subject to self-employment tax, but your wages will be subject to Social Security taxes.
Are you planning to provide fringe benefits such as health and life insurance? If so, you should be aware that the costs of providing such benefits to a more than 2% shareholder are deductible by the entity but are taxable to the recipient.
𝐁𝐞 𝐂𝐚𝐫𝐞𝐟𝐮𝐥 𝐖𝐢𝐭𝐡 𝐒 𝐒𝐭𝐚𝐭𝐮𝐬
Also be aware that the S corporation could inadvertently lose its S status if you or your partners 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 you against this risk, it’s a good idea for each of you to sign an agreement promising not to make any transfers that would jeopardize the S election.
𝐂𝐨𝐧𝐬𝐮𝐥𝐭 𝐓𝐑𝐏 𝐒𝐮𝐦𝐧𝐞𝐫 𝐛𝐞𝐟𝐨𝐫𝐞 𝐟𝐢𝐧𝐚𝐥𝐢𝐳𝐢𝐧𝐠 𝐲𝐨𝐮𝐫 𝐜𝐡𝐨𝐢𝐜𝐞 𝐨𝐟 𝐞𝐧𝐭𝐢𝐭𝐲. We can answer any questions you have and assist in launching your new venture. Every business situation is different and we can advise you to select the appropriate business entity for your needs. We have three locations in Fayetteville and Dunn, NC. Visit our website at www.trpsumner.com for more information.