S Corp: Advantages and Disadvantages for Small Business

Choosing the right structure for your small business is one of the most important decisions you’ll make. Your choice will affect how you’re taxed, how much paperwork you’ll need to complete, and how much personal risk you take on. One option that works well for some small business owners in the U.S. is the S Corporation, or S Corp.

What Is an S Corporation (S Corp)?

An S Corporation is a special type of business structure that’s similar to a C Corporation. Both are separate legal entities from their owners. However, S Corps can avoid double taxation. Instead of paying corporate taxes, the business passes income, losses, and credits to its shareholders, who report them on their personal tax returns.

4 Advantages of an S Corp

1. Limited Liability Protection

As with a C Corporation, an S Corp limits how much personal risk you take on. Your personal assets—like your home or savings—are protected if the business is ever sued. You’re only responsible for the amount you’ve invested in the company.

2. Pass-Through Taxation

S Corps don’t pay corporate income tax. Instead, profits or losses pass through to the owners’ personal tax returns. Owners can also receive profit distributions that aren’t subject to Social Security or Medicare taxes, as long as they’re paid a fair wage.

3. Ability to Raise Money Through Stock

S Corps can raise capital by selling stock. While only one class of stock is allowed, the process of issuing it is fairly simple. This option gives small businesses a way to bring in investors, though some may prefer the flexibility of multiple stock classes.

4. Perpetual Existence

Even if the owner of an S Corp leaves or passes away, the business can continue operating. This structure makes it easier to transfer ownership or sell the company in the future, which adds long-term value and stability.

4 Disadvantages of an S Corp

1. Reasonable Compensation Rule

When you work for your S Corp, you must pay yourself a “reasonable” salary based on your role. If you underpay yourself to avoid payroll taxes, the IRS may reclassify profits as wages—and charge back taxes, penalties, and interest. Also worth noting: An S Corp can’t have more than 100 shareholders. All shareholders must be U.S. citizens or residents, and only individuals or certain trusts and estates can hold shares.

2. Strict Income Distribution Rules

S Corps must divide profits and losses based on how much of the company each person owns. For example, if you own 30% of the company, you must receive 30% of the profits—even if other owners contributed more work or money.

3. PSC (Professional Services Corporation) Label

If you’re the sole owner and provide professional services, the IRS may classify your business as a Professional Services Corporation (PCS). This means all of your profits could be subject to self-employment tax, increasing your tax burden and audit risk.

4. Ongoing Paperwork and Fees

S Corps have to meet ongoing requirements, such as filing annual reports, submitting federal and state forms, and paying certain fees. Each U.S. jurisdiction has different rules, so you’ll need to stay up to date on your jurisdiction’s requirements.

More Tools and Resources Available for Independent Contractors

If you’re seeking more resources to support your journey as an independent contractor, visit MBO’s blog for expert insights and advice. Our blog covers a wide range of topics, from business development to financial planning to client management, so that you can succeed in the world of self-employment.

The information provided in the MBO blog does not constitute legal, tax or financial advice. It does not take into account your particular circumstances, objectives, legal and financial situation or needs. Before acting on any information in the MBO blog you should consider the appropriateness of the information for your situation in consultation with a professional advisor of your choosing.