S corps enjoy a great reputation with small business owners because they offer the benefits of a sole proprietorship or partnership without the drawbacks of a traditional C corporation.
When it comes to achieving a balance between simple business ownership and corporate advantages, you won't find a better vehicle than an S corp.
But that doesn't mean that S corps are footloose and problem-free. Even though an S corp can be a beneficial structure for some companies, they aren't appropriate for every small business. With that in mind, here some S corp disadvantages to keep on your radar:
- Regulatory requirements. Despite its similarities to a sole proprietorship or partnership, an S corp is a corporate business entity that is subject to specific regulatory requirements. If you aren't prepared to deal with increased regulations, you should probably re-examine your interest in S corps.
- Added expense. Compared to more basic business models, S corps can be expensive to establish and maintain. Additional costs like the preparation of corporate tax documents aren't necessarily prohibitive, but depending on the size of your operation you may need to conduct a cost-benefit analysis before you make any decisions.
- IRS scrutiny. S corps don't automatically receive more scrutiny than other types of businesses. However, the IRS does keep a close eye on shareholder employees who push a high percentage of income into the category of a nonwage shareholder distribution. The IRS also monitors S corps that habitually report business losses to offset personal income.
- Ownership restrictions. S corps are limited to 100 shareholders or less, which is usually only a problem if you plan to take the company public. But unlike a sole proprietorship or partnership, all of the company's owners must be US citizens or permanent residents.
- Health insurance deductibility. If you're a one-person operation, an S corp can limit your self-employment health insurance deduction. Sole proprietors can deduct the cost of a single health insurance plan, but deductibility in an S corp is limited to group plans purchased by the corporation. The problem is that group plans usually aren't available for one-person groups, effectively negating the benefit of tax deductibility.