As part of the Veracity Capital Knowledge Series: Beyond Taxes, we’re covering key financial topics to help you make informed decisions. In this installment, we review the potential benefits and considerations of structuring your business as an S Corporation (S Corp).

Choosing the right business structure is a critical decision, and an S Corp could be a smart choice for some business owners. However, it’s not a one-size-fits-all solution. Let’s explore what makes an S Corp unique and whether this structure aligns with your business and financial goals.

What is an S Corp?

An S Corp combines the limited liability protections of a corporation with the tax advantages of a pass-through entity. This means business profits (and losses) flow directly to the owners’ personal tax returns, avoiding the double taxation seen with traditional C Corps. Sounds appealing, right? That said, this structure works best under specific circumstances.

Who Should Consider an S Corp?

Business owners with substantial net profit

If your business generates significant profits beyond what you’d pay yourself as a reasonable salary, an S Corp might help you save on taxes. Here’s why: S Corp owners can divide their income into two streams:

• • Reasonable salary: Subject to Social Security and Medicare taxes (payroll taxes).
  • Distributions (profits): Not subject to payroll taxes and could potentially qualify for the qualified business income deduction.

By minimizing the portion of income classified as salary, you can potentially reduce self-employment tax liability. However, the IRS expects salaries to be “reasonable,” so it’s critical to strike the right balance.

Small business owners seeking limited liability

One of the biggest advantages of an S Corp is the protection of personal assets. If your business incurs debts or faces legal challenges, your personal property – such as your home, car, or savings – is generally off-limits to creditors, provided you follow corporate formalities.

Businesses with few shareholders

The IRS caps S Corps at 100 shareholders, all of whom must be U.S. citizens or resident aliens. This makes the structure ideal for small, closely held businesses rather than large enterprises.

Service-based businesses

Consultants, freelancers, real estate agents, and other service providers often find S Corp status advantageous. These businesses typically have lower operational costs and don’t require extensive physical infrastructure, allowing them to focus on maximizing tax savings.

Owners seeking tax-filing flexibility

As a pass-through entity, an S Corp’s profits are taxed only at the personal level, avoiding the double taxation that applies to C Corps. This can simplify tax obligations and potentially save you money.

Businesses with predictable revenue

If your business enjoys steady, predictable income, it’s easier to determine a reasonable salary and plan for distributions. This predictability enhances the benefits of the S Corp structure.

Entrepreneurs comfortable with formalities

S Corps require some administrative effort, including filing articles of incorporation, adopting bylaws, holding annual meetings, and keeping accurate corporate minutes and records. If you’re organized and don’t mind these responsibilities, the benefits can outweigh the paperwork

Who Might Not Benefit from an S Corp? 

An S Corp isn’t the right fit for every business. Here are some scenarios where this structure might not make sense: 

Startups with low profits – The costs of maintaining an S Corp – such as payroll services and legal compliance – may outweigh the tax savings for businesses with  minimal income.  

High-growth businesses seeking investors –  With a 100-shareholder limit and restrictions on stock types, S Corps may not be suitable for businesses looking to attract venture capital or multiple investors. 

Owners unable to pay reasonable salary: Skimping on salary to maximize distributions can invite IRS penalties and audits. 

Things to Do  Before You Decide 

Forming an S Corp is not a one-size-fits-all solution. Here are three critical steps to take before making your decision: 

1. 1. Consult a tax professional – Determine what constitutes a “reasonable salary” for your role and calculate potential tax savings compared to your current structure. 

1. 2. Understand state-specific rules – Some states do not recognize S Corp status or impose additional taxes. Knowing these nuances can help you avoid surprises. 

1. 3. Weigh the administrative costs – Ensure the ongoing requirement – like maintaining records and filing specific forms – are manageable for you. 

The Bottom Line 

An S Corp can be a powerful tool for tax savings and liability protection, especially for small-to-medium businesses with consistent profits and owners ready to handle corporate formalities. As with any financial decision, it’s important to weigh the pros and cons carefully and seek professional advice tailored to your unique situation. 

Our team is here to help. Whether you’re evaluating your options, have questions about how an S Corp fits into your financial plan, or are ready to take the next steps, we’re ready to guide you every step of the way. 

If you have questions or want to learn more feel free to email us at [email protected], or schedule an introductory meeting here.

Advisory services offered through Veracity Capital, LLC, a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.