Whether you’re setting up a new company in the Greater Portland area, or you’ve been in business for years, you need to evaluate which legal structure is best for your enterprise. No one option is best for every type of operation. The number of owners, taxes, and your business goals are all important factors to consider.
Since choosing a business structure can be a complicated process with long-range consequences, you should consult Filler & Associates when making your considerations. To help get you started, we have come up with some pros and cons of S corps:
Limited liability. An S corp lets you and any co-owners restrict personal liability. If your company is unable to pay its debts, the business assets would be available to creditors but your personal belongings would remain protected. You may not, however, have total protection from liability – if your business specializes in offering advice, for example, you won’t be protected if the advice you give personally is wrong.
Avoid double taxation. With an S corporation, you can avoid two-tiered taxation. You won’t have to pay corporate taxes and then pay personal taxes on the same income. An S corp does not pay federal taxes. Earnings-and losses-are passed through to the owner. And because income is taxed to the owner, you can avoid problems arising from the corporate alternative minimum tax. However, an S corporation must still file a tax return, and some states impose taxes. Filler & Associates can help you negotiate Maine tax laws.
Treatment of losses. An S corp may be a wise choice if you think you might have operating losses in the first couple of years in business. For example, if you invest $100,000 in your small business and end up with a loss of $25,000, the deficit is passed through to you and any other owners on a pro rata basis. You can take the loss against other income on your personal tax returns. Remember, however, that you cannot take current-year losses that exceed your adjusted basis in the company.
Easy termination. A business’ S status can be terminated either voluntarily or involuntarily. To voluntarily terminate the S status, there must be a vote of shareholders owning more than 50 percent of the company’s total outstanding voting shares. Involuntary termination can result from not following the restrictions placed on S corps.
Shareholder FICA. There are no FICA(Medicare and Social Security) taxes on pro rata taxable income and dividend distributions. In general, company contributions to a retirement plan on behalf of a shareholder-employee are also not subject to FICA taxes. In a family business, it is possible to get some tax advantages by shifting the owners’ income to other family members by making them employees or shareholders or both.
Warning: It may be tempting to see major employment tax savings by cutting your compensation and taking large dividend distributions instead of salary. But the IRS closely watches “reasonable compensation.” If the tax agency finds that compensation is inadequate, it can recharacterize your dividend distributions as wages, which means you become liable for unpaid employment taxes, penalties, and interest.
Appreciated assets. Any assets that are owned by your company and have appreciated cannot be distributed to you and your co-owners without generating a tax bill.
Asset withdrawal. Taking money or assets out of an S corporation can be an administrative headache. For example, the withdrawal must be characterized for tax purposes as compensation, a dividend, a loan, or other payment. Compensation means payroll taxes are due and W-2 forms and payroll tax returns must be filed. A loan requires a loan document.
Single stock class. An S corporation can issue only one class of stock, which must have identical rights when it comes to dividends and the distribution of company assets if the business is liquidated. This can make it difficult to raise cash through a stock offering.
Ultimately, an S corp provides a good option for a small enterprise that would otherwise be significantly taxed under the traditional corporate model. When selecting or considering a new legal structure, Filler & Associates can help small business owners review their options and make a sound decision.