One of the most important and impacting decisions a business owner makes is deciding what type of entity is best suited for their company. Below are benefits from electing to be an S Corp, but also items to be aware of.
Anticipating losses
If you expect that the business will incur losses in its early years, an S corporation is generally 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 returns to the extent of your basis in the stock and in any loans you make to the entity. Losses that can’t be deducted because they exceed your basis are carried forward and can be deducted by you when there’s sufficient basis.
Once the S corporation begins to earn profits, the income will be taxed directly to you whether or not it’s distributed. It will be reported on your individual tax return and be aggregated with income from other sources. To the extent the income is passed through to you as qualified business income, you’ll be eligible to take the 20% pass-through deduction, subject to various limitations. Your share of the S corporation’s income won’t be subject to self-employment tax, but your wages will be subject to Social Security taxes.
Are you planning to provide fringe benefits such as health and life insurance? If so, you should be aware that the costs of providing such benefits to a more than 2% shareholder are deductible by the entity but are also taxable to the recipient.
Be careful with S status
Also be aware that an S corporation could inadvertently lose its S status if you or your partners 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 you against this risk, it’s a good idea for each of you to sign an agreement promising not to make any transfers that would jeopardize the S election.
Consult with your Rudler, PSC advisor at 859-331-1717 and your attorney before finalizing your choice of entity. We would be happy to answer any questions and assist in launching your new venture.
RUDLER, PSC CPAs and Business Advisors
This week's Rudler Review is presented by Kendra Anderson, Staff Accountant, and S. Gregor Lamping, CPA.
If you would like to discuss your particular situation, contact Kendra or Greg at 859-331-1717.
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