For those who are forming a business, it is important to understand the different types of business entities available. The Internal Revenue Service taxes each business entity differently. Understanding the pros and cons of each business structure can help business owners make informed choices that will benefit them during tax time.
While most people may be familiar with a limited liability company (LLC), or a sole proprietorship, the pros and cons of an S corporation may be less well known.
S corporations avoid double taxation
S corporations share many of the benefits of certain corporate business entities, such as liability protection and the ability to have shareholders. According to the Internal Revenue Service website, S corporations also avoid some of the double taxations that other corporations are subject to. This single-level tax occurs when shareholders report profits on their income taxes.
Conversely, C corporation profits are subject to double taxation. Prior to distributing profits to shareholders, the IRS taxes C corporations on the profits of the business. Then, the shareholders are responsible for taxes on the income they receive after distribution.
S corporations may have more restrictions
While there are some clear tax benefits when it comes to choosing an S corporation as a business entity, there are also disadvantages as well. For example, FindLaw experts state that S corporation shareholder tax rates may be higher than shareholders of other entities at the same income level. Additionally, things like estate planning may be more complicated for shareholders in an S corporation.
While there are many benefits of an S corporation status, there are some significant drawbacks as well.