Deciding to leave your 9 to 5 cubicle job to open up your own small business is an extremely big decision to make, but that initial decision is only the beginning of the journey. Once you decide to become an entrepreneur, you will have an unending abundance of choices to make on a daily basis: where you want your business to be located, who you want to hire as employees and how you want to market your business are just a few of those decisions to be made.
Something you will need to decide early on is what kind of legal structure you want to incorporate your new business with. Forming an incorporation is important to do from the get-go because it will protect your assets, provide tax breaks and give your business the sense of legitimacy it deserves. As far as incorporation goes, there are a few different choices available with their own sets of advantages and disadvantages, but here you will learn specifically about the benefits of incorporating with an S-Corporation.
An S-Corporation (also known as an S-Corp) is a special type of corporation that draws its designation from subsection S of the tax code. To start an S-Corp, a small business owner starts a C-Corporation in the state where it is headquartered, then files for S-Corporation status with the IRS. While an S-Corp is similar to a C-Corporation, the differing income and self-employment tax regulations set the two apart. You’ll still be able to gain plenty of credibility for your business, along with the following six benefits, when you form an S-Corporation.
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1. Pass Through Taxation
Like an LLC, an S-Corporation does not pay taxes at the corporate level. Any income or losses are reported only on the personal income taxes of the business owner’s. As a result, this avoids the issue of double taxation that affects C-Corporations. Since net losses are “passed through” as well, the individual shareholder may be able to reduce his or her tax liability by offsetting other income with any S-Corp losses. There is an important caveat however: any shareholder who works for the company must pay him or herself reasonable compensation. Basically, this means that the shareholder must be paid fair market value, or the IRS might reclassify any additional corporate earnings as "wages."
2. Limited Liability for Your Business’ Actions
According to the IRS, S-Corporations are "considered by law to be a unique entity, separate and apart from those who own it." The owners of an S-Corp have only limited liability for the actions of the company. This means they can’t be held responsible for its actions or debts unless the business owners have signed a personal guarantee.
3. Avoid Self-Employment Taxes
The owners of an S-Corporation are considered employees of the company, not owners. So the “owners” of an S-Corp get to skip out on the self-employment taxes that members of an LLC would have to pay.
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4. Plan Ahead with Reduced Taxable Gains
If you open your business with the intention to sell it at some point or if you wanted to work on a side project for a few years but you decide to make the move back to reality at some point, then the S-Corp can be attractive for yet another reason. When the company is sold, an owner’s taxable gains from the sale can be less than they would have been if you were selling a C-Corp.
5. They Have a Life of Their Own
This is good news if you plan on making sure your business sticks around for a while; you don’t plan on just creating a side project to sell in a few years. Unlike an LLC, S-Corporations have an unlimited life span. Your business will continue to exist even if you leave the company. In fact, the business can even continue operating without too much trouble.
6. Easy to Mold
Say you have the best intentions to run your own business and stick with it through the years, but something comes up and you have no choice but to transfer ownership. In some forms of incorporating, this can mean a lot of extra hassle. However, with an S-Corporation, ownership is easily transferred through the sale of the company stock.
Additionally, if after a while you think an S-Corporation isn’t for you and maybe you’d like to stick with a C-Corporation after all, you can easily drop the S-Corp status with the IRS.