In general, S Corporations are valuable when you require the limited liability protection that a corporation provides and when your business is not profitable. S corporations are pass through entities which means that all income is passed directly to the shareholders who pay taxes under their own individual income tax rates. As a result, the S corporation itself does not have to pay any federal income taxes. Before electing to create an S corporation, here are a few questions that you should be asking yourself.

Do You Absolutely Require Limited Liability?

Filing for an S corporation requires a significant amount of paperwork compared to a sole proprietorship. Even though the income for an S corporation is passed directly to the individual, a separate tax return must be filed because an S corp is treated as a separate tax paying entity. In addition, an S corporation must file and pay employment taxes on its employees as well.

You must also take into consideration that your state may charge a fee as well in order to be incorporated. For example, the state of California charges a minimum 800 dollar yearly fee or 1.5% tax(whichever is higher) to maintain the corporation status. This fee exists whether or not you make any money at all.

Is it worth the hassle? If you absolutely require limited liability, then the answer is yes. However, also keep in the back of your mind that you can get product liability insurance with a sole proprietorship to protect your assets with much less hassle.

Is Your Business Profitable?

If the answer is yes, then chances are an S corp is not a good idea. The main advantage of an S corp is that you can pass your losses directly into your individual income tax return. As soon as your business is profitable, there are alternative corporate structures to consider such as a C corporation in which you can save more on your taxes.

Do you Qualify?

In order to qualify for S corporation status, you must meet the following guidelines.

• All shareholders must be US citizens or permanent residents.
• You can’t have more than 75 shareholders.
• You can only issue one class of stock. All stock you issue has the same privileges for everyone

Do You Want To Reinvest Profits Back Into Your Business?

If the answer is yes, then an S corporation is not the answer for you. Because S corporations are not allowed to keep earnings within the corporation, they must be paid out to shareholders every year. As a result, no money stays with the corporation at all. All of the profits are taxed at your individual income tax bracket.

How Do I Form An S Corp?

Forming an S Corporation can be a confusing task. There are several different forms that you need to fill out and many rules associated with starting and running an S Corp. If you are thinking about forming an S Corp, I highly recommend having a third party do the paperwork for you.

For example My Corporation is an Intuit company that specializes in small business formation for a very reasonable fee. Rather than have to trudge through all of the different forms and legalese, it’s far easier to have My Corporation handle everything for you.

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