S-Corporation: Advantaged & Disadvantages By Athulya - April 26, 2019 Last Updated at: Oct 23, 2019 0 1146 S-Corporation: Advantaged & Disadvantages An S corporation is a special type of corporation which is established only for the purpose of federal taxes. The essential feature that distinguishes an S corporation from other business entities is that they are a pass-through entity, through an election made. In layman’s term, the taxes and other losses incurred are not borne by the S corporation (meaning that they do not pay any income-taxes), rather the income or losses are equally distributed among its shareholders. A special type of corporation established for the federal tax purpose is called S corporation. The advantage of this type of corporation is that the S corporation is not liable to pay the taxes and face the losses. Here, you will get to know more about the advantages and disadvantages of this type of corporation. The shareholders also have the responsibility to diligently report the income or losses borne, on their own records of income-tax returns. This does away with the issue of double-taxation, wherein once the individuals bear the taxes in the capacity of a shareholder of the enterprise and then again as individual assessees. The election made in an S-corporation is with the Internal Revenue Service (IRS). The establishment of an S-corporation is done similar to that of a company, by filing Articles of Incorporation with the concerned government body. Incorporate Your Business in USA Much of the functioning of an S-Corporation is similar to a C corporation, it issues stock and is governed by a team of directors, officers, shareholders, etc. Moreover, the liability sharing is also the same for the shareholders of an S-Corporation as it is for their counterparts in a C-Corporation. Here are some of the advantages and disadvantages of having an S-Corporation as against a C-Corporation. ADVANTAGES: The peculiar structure of an S-Corporation comes to the benefit of the business entity while it is in the stage of transfer or termination. Sole-Proprietorship and other general partnerships miss out on the advantages S-Corporations enjoy by way of their structuring. Limited Liability of Shareholders: The peculiar nature of an s-corporation is that it offers protection to the personal assets of the shareholders and does not hold them personally liable for any losses, liabilities or debts of the corporation. The claim of the creditors does not extend to the assets of the shareholders in order to recover their claim amount. Therefore, unlike a general partnership or sole proprietorship, the business entity and the shareholders are considered as different entities altogether. Defeats Double Taxation: The system of taxation that an S Corporation follows makes it a lot easier as it avoids any occurrences of double-taxation. The taxation for both the corporation and the individual is merged and reflected in the separate income tax returns of the shareholders. If the business or the corporation suffers any losses, it is ‘passed-through’ to shareholders who report it on their personal income tax returns. Such a system of taxation is extremely beneficial when it comes to budding businesses and start-ups. Moreover, the characterization of income under an S-Corporation is such that it reduces the tax-liability on the shareholders. It is often for this tax-favourable characterization of income that S-Corporations are preferred. In situations of transfer or termination as well, there are less adverse tax consequences. The S corporation does not need to make adjustments to the property basis or comply with complicated accounting rules when an ownership interest is transferred. Method of Cash Accounting: Unlike other corporations, the S-Corporation do not use the accrual method of accounting unless they are considered to be small corporations or they have an inventory. Increased Credibility: An S Corporation has increased credibility amongst potential customers, employees and vendors. There is increased credibility because they show a formal commitment to business enterprises. Disadvantages: Fees and other expenses: In order to function as an S-Corporation it is necessary that the Articles of Incorporation be filed, a registered agent be obtained as against some fee, the appropriation fee and other expenses be paid. The imposition of a fee on an S-Corporation is a matter of the State Government and thus, some states also impose a certain ongoing fee on such entities. These are the expenses that a sole proprietor or a general partnership doesn’t bear. Unlike other general entities, an S corporation must adopt a calendar year as its tax year unless it can establish a business purpose for having a fiscal year. Restrictions on Stock ownership: The case of ownership of stock is somewhat different when it comes to an S-Corporation. S-Corporations are entitled to have only one class of stock with both votings as well as non-voting shares. There are certain operative restrictions when it comes to shareholding. An S-Corporation cannot have more than 100 shareholders. Moreover, there can also not be different classes of investors with dividends and distribution rights. Rigid Structure of Income and Loss: Because of restrictions on stock ownership limited to only one class of shares, an S-Corporation cannot allocate income or losses to all shareholders. In an S-Corporation, the allocation of income and loss is governed by stock ownership and not by an agreement. 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