One of the services we offer here at Strojny Financial Services is business planning—helping small businesses establish essential strategies for every stage in the life cycle of the business: maximizing cash flow, planning for growth, minimizing taxes, bringing in a successor or selling your company, and more.
But, before we can get into any of that, we help entrepreneurs determine which entity is best suited for their business needs. While Strojny Financial Services does not offer legal advice, we can advise on the tax-related issues of entity formation, while strongly suggesting that business owners seek both legal and tax advice when forming a new legal business entity.
When deciding on the right structure for your business, understanding the benefits of different entity types is crucial. One popular option for small to medium-sized businesses is the S Corporation. This entity offers a blend of tax advantages and operational flexibility, making it an appealing choice for many entrepreneurs.
No Self-Employment Tax on Earnings. In an S Corporation, shareholders can be employees of the company and receive a salary. This salary is subject to payroll taxes, but the remaining profits distributed as dividends are not subject to self-employment taxes. This structure can result in significant tax savings, as only the salary portion is subject to Medicare and Social Security taxes, not the entire profit.
Owner Payroll Allowed. Because shareholders can be employees of the company and receive a salary, that also means that business owners can be on the company’s payroll. A common strategy is for business owners to set up their S Corporation salary as a revenue split between salary and distributions, but the percentage of the split has a lot to do with how the owner contributes to the company and how well the business does financially.
Asset Protection. Similar to C Corporations and LLCs, S Corporations provide limited liability protection to their shareholders. This means that the personal assets of shareholders are generally protected from business debts and legal claims. This protection can help give you peace of mind, knowing that your personal wealth is safeguarded against potential business liabilities.
Easy Ownership Transfer. Transferring ownership of an S Corporation is generally easier than other business entities and can be done without adverse tax consequences. The process can be structured as an outright sale or a gradual sale and is facilitate by a written sales agreement.
Reduced Quarterly Estimated Tax Payments. Quarterly taxes are important for those who are self-employed or part of an S Corporation. Estimated taxes cover the tax due on the remaining business profit or the portion of your business income that is not your salary.
Although there are several advantages to an S Corporation, there are also some disadvantages to consider when deciding on a legal business entity.
No Commingling of Owner’s and Business’s Funds. Business owners in an S Corporation must maintain separate accounts, define financial responsibilities, keep accurate financial records, document contributions, and identify transactions and understand how to account for them before recording them on the P&L.
Owner Payroll Required. Just as the owner being allowed to be on the company’s payroll is an advantage, it’s required, which can be a disadvantage. There are some instances when it’s not as tax-efficient for the owner to be on the payroll, but with an S Corporation, there is no avoiding it.
Administrative Cost. Everything comes with a cost, and an S Corporation is no exception. There are additional administrative costs associated with state registration and filing fees for an S Corporation, as well as the tax return required.
Closer IRS Scrutiny. The IRS has recently added extra scrutiny to S Corporations because it has grown sensitive to the potential for manipulating the tax laws in this area.
Owner Taxation of Fringe Benefits. Shareholders who own more than 2% of the company may have limitations on fringe benefits that are available to C Corporation employees.
Reduced Qualified Business Income (QBI) Deduction. The QBI deduction allows S Corporation owners to deduct up to 20% of their profits from their income taxes, which can be less than what is allowed by other entities.
Choosing an S Corporation structure can be beneficial for many small to medium-sized businesses, especially those looking for tax advantages and liability protection. However, it's crucial to weigh the benefits against the potential drawbacks and ensure that the business meets the eligibility requirements. In addition to consulting with Strojny Financial Services for the tax-related issues of entity formation, a legal advisor can help determine if an S Corporation is the best fit for your specific situation.