S corporations the most suitable form of business for the new venture
Here is an explanation of the reasons why.
The biggest advantage of an S corporation over a partnership is that as S corporation shareholders
you 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.
One might 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 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. Your share of the S corporation’s income will not be subject to self-employment tax,
but your wages will be subject to social security taxes.
The 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
you since each of you will own more than 2% of the entity.
As I mentioned, the S corporation could inadvertently lose its S status if either of you 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, you may want to sign an
agreement promising not to make any transfers that would endanger the S election.
I hope you find this explanation helpful explaining S Corporation as a choice of entity. If you have
questions, please do not hesitate to call.