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An S-corporation, its advantages and disadvantages

When Minnesota entrepreneurs begin to plan a business, they will have numerous options in their choice of business entity. Business formation can be complicated and making the right decision as to what kind of strategy to use can be the difference between success and failure, profit and loss. One option that is available and should be considered depending on the circumstances is an S-corporation. Before making that decision, however, it is imperative to know what an S-corporation is and what its advantages and disadvantages are.

A corporation that is created via IRS tax election is known as an S-corporation. If a corporation is eligible, it can avoid double taxation if it chooses to be an S-corporation. To be an S-corporation, the business must be chartered as a corporation in the state in which it is headquartered. The IRS considers S-corporations to be unique entities and separate from its owners. This will limit the owner's financial liability in the event of a problem. There is a limit to the liability protection.

The advantages of having an S-corporation are the tax savings, the business expense tax credits and the independent life. S-corporation shareholders are the only employees who will be subjected to the employment tax based on the net income of the business. The remainder of the income will be paid to the owner as a form of distribution. This will be subject to a lower tax rate. The business expense tax credits means that expenses incurred by shareholders or employees can be written off. Independent life means that the business will be separate from the shareholders. A shareholder who departs the company or sells the shares will not affect how the corporation does business.

Disadvantages include a stricter operational process and shareholder compensation requirements. With stricter operational process, the S-corporations need to have director and shareholder meetings on a scheduled basis. There must be minutes taken at the meetings. By-laws, stock transfers and the maintaining of records must be adopted and updated. Shareholder compensation requirements means that the shareholder is required to receive reasonable compensation. If there is a low salary and high distribution, the IRS will note it and intervene.

Given the complicated nature of business formation, financing and other issues, business startups need to be cognizant of the different options available. Speaking to a legal professional experienced in S-corporations can be helpful to determining the best course of action.

Source: sba.gov, "S-corporation," accessed on Jan. 11, 2016

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