S-Corp vs. Other Business Structures: What's Best for Your Small Business?

Choosing the right business structure is a key decision for small business owners. Common options include sole proprietorships, partnerships, LLCs, and corporations (including S-Corps and C-Corps).

The structure you select is a critical decision. It materially affects your taxes, personal liability, and the growth of your personal wealth. Getting it right can save you money and headaches down the road.

NOTE: These are complex decisions. We’ve met plenty of business owners who have tried to make these decisions alone, and as a result made costly mistakes. You should work with qualified tax, financial, and legal professionals to discuss and implement these ideas.

What is an S-Corporation?

An S-Corporation is a special type of corporation that is not taxed at the corporation level. Instead, it passes corporate income, losses, deductions, and credits through to shareholders for federal tax purposes. Unlike a C-Corporation, the S-Corporation does not pay Federal income taxes.

To be eligible for S-Corp taxation, a business must:

• Be a domestic corporation or LLC (not foreign)
• Have no more than 100 shareholders
• Make sure all shareholders agree to the election
• Have only one class of stock
• Not be a bank or insurance company
• Have shareholders that are only individuals, estates, tax-exempt organizations, and certain types of trusts

On top of these requirements, S-Corps must maintain a formal structure, including a board of directors, regular shareholder meetings, and detailed financial records.

Advantages of S-Corp Structure

S-Corps offer several key advantages for small business owners:

• Pass-through taxation means the business itself doesn't pay federal income taxes. Instead, profits and losses pass through to shareholders, who report them on their personal tax returns. This avoids the double taxation issue faced by C-Corps. NOTE: state taxation of S-Corps can vary and should be discussed directly with your tax advisor.
  
  
• S-Corps provide a level of personal asset protection. Shareholders' personal assets are generally shielded from business debts and liabilities, reducing personal financial risk. As mentioned above, it’s important to discuss the specifics of asset protection with an attorney.
  
  
• S-Corps offer flexibility in how owners can be paid. Shareholders can receive both a salary and distributions, which can help optimize tax strategies. However, the IRS requires that owner-employees be paid a "reasonable" salary before taking distributions.
  
  
• The prime benefit of S-Corp taxation is that shareholders do not have to pay self-employment taxes (15.3%!) on their share of business profits. This provides significant tax savings to those who can properly plan for the salary vs. profit decision. 
  
  

Potential Drawbacks of S-Corps

S-Corps come with some potential downsides:

1. S-Corps must follow strict operational rules:
   They need to hold regular board meetings, keep detailed minutes, and maintain accurate financial records. This can be time-consuming for small business owners.
   
   
2. Ownership is limited to 100 shareholders, who must be U.S. citizens or residents: This can restrict growth and funding options. S-Corps also can't have partnerships, corporations, or non-resident aliens as shareholders.
   
   
3. Utilizing an S-Corp structure is costlier than simpler business structures:
   You may need to pay for professional help with tax filings, payroll management, and maintaining corporate records. These added costs can eat into profits, especially for smaller businesses.

Comparing S-Corps to Other Business Structures  

Factors to Consider When Choosing an S-Corporation or other  Business Structure

When choosing an S-Corporation or other business structure, small business owners should consider several key factors:

When an S-Corp Might Be the Right Choice

S-Corps typically work well for businesses who meet the eligibility requirements and have steady, significant profits. If you can pay yourself a reasonable salary and still have leftover profits, you might save enough on self-employment taxes to warrant an S-Corp election.

A tax professional can help run a break-even analysis to show the cost/benefit of an S-Corp election at your unique income level.

If you want liability protection and self-employment tax savings but prefer a simpler tax situation than a C-Corp, an S-Corp could be ideal.

The Role of Professional Advice in Business Structure Decisions

Consulting with tax professionals:

Tax professionals can help you understand the complex tax implications of different business structures. They can run projections to show how each structure might affect your tax bill now and in the future.

A tax expert can also help you stay compliant with IRS rules, which is especially important for S-Corps.

How wealth advisors can help with the financial implications of utilizing an S-Corp: 

Wealth advisors look at the big picture of your finances. They can help you align your business structure with your personal financial goals. Part of this is evaluating how your selection of an S-Corp or other business structure may affect your financial goals. 

For example, they might help you balance taking money out of the business now versus reinvesting for future growth. They can also help you plan for retirement and consider how your business fits into your overall wealth strategy.

Your Next Steps: Determining if the S-Corp is Right for your Business

Choosing the right business structure is a crucial decision that affects your taxes, liability, and growth potential.

While S-Corps offer benefits like pass-through taxation and potential tax savings, they also come with strict rules and may not be the best fit for every business.

To make the best choice for your unique situation, consider seeking guidance from tax, legal, and wealth management professionals. 

When you partner with Burney Tax Advisors for your tax preparation & planning needs, you get access to our close, collaborative relationship with wealth advisors at Burney Wealth Management. 

This collaborative approach is a great way to keep all your financial professionals working in the same direction to help you in your needs as a business owner.