An S corporation, also known as an S subchapter, is a type of legal business entity that falls under specific Internal Revenue Code requirements. S Corporations can pass income, deducations, credits and losses directly to shareholders. S Corporations can be favored as a business structure because shareholders can avoid double taxation. As a result, shareholders are able to protect other assets (outside ones invested in the S corporation) against liability.
What makes S Corporations advantageous is that they avoid double taxation (paying taxes at a corporate level and an individual level). If your business is an S Corporation, income is taxed like partnerships. Income is “passed” to shareholders and it is not taxed at a corporate level. This “passing” allows owners to participate in centralized management and limited personal liability, while avoiding double taxation.
The Pitfalls of S Corporations
If a business is predicted to have losses, an LLC could be more advantageous than a S Corporation. This is because S Corporation shareholders cannot write off losses that exceed their actual investments. LLC members are able to write off investments equal to their investments in addition to the allocable share of LLC debt.
In S Corporations, both profits and losses are distributed to shareholders in proportion to stock ownership through a year’s time. In contrast, LLC members can allocate losses and profits disproportionately: allocating profits on one basis and losses on another.
S Corporations are limited to one class of stock while LLCs can have different financial interests.