An S corp is an appealing business structure for many small business owners.
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Not quite a C corporation but definitely not a sole proprietorship, in many ways S corps offer the best of both worlds for business-savvy entrepreneurs.
Although S corps are similar to other types of incorporated business entities, there are also some distinct differences. S corps are taxed more like sole proprietorships and partnerships than C corporations with prorated income and losses reported on shareholders individual tax returns. Even though S corps are required to file federal tax returns, they don't pay federal income tax as a corporate entity.
The unique tax structure and other features result in some significant S corps advantages that every small business owner should be aware of:
- Treatment of business losses. Unlike C corporations, S corps let you apply corporate losses against personal income. This means that owners (or shareholders) can take advantage of business losses to offset their spouse's or their own outside income – while still benefitting from some of the other features of an incorporated business.
- Limited personal liability. S corps are similar to sole proprietorships and partnerships when it comes to taxation. But when it comes to liability, S corps significantly reduce the business owner's personal exposure. As a rule, shareholders are not liable for the corporation's debts simply because of their ownership interest.
- Reduced FICA exposure. An S corps business structure also reduces the owner's exposure to FICA and self-employment taxes since shareholder profits are not taxed as self-employment income. You'll still have to pay self-employment tax on a reasonable salary level, but it is possible to shelter a certain percentage of income from FICA's dreaded 15.3%.
- No corporate tax. Another important benefit of S corps is that they are not subject to corporate tax. All income flows through to the shareholders personal income tax returns, eliminating the business' exposure to high corporate rates.
- Investment capacity. Investors tend to avoid sole proprietorships and partnerships. An S corp gives entrepreneurs the ability to attract investment income without sacrificing the characteristics they appreciate about owning a smaller company.