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Setting up as an S-Corporation allows you to have the limited liability of the regular corporation and the pass-through taxation of a sole proprietorship or a partnership. In other words, you pay taxes from corporate income on your personal income taxes. Nowadays, for a small entrepreneur, it is more convenient to set up a Limited Liability Company (LLC) as it hold the limited liability benefits of the corporation and the flexibility of a sole proprietorship or a partnership.

Advantages of an S-Corporation

Forming an S-Corporation can have its advantages, some are:

• If you plan to sell your S-Corporation, the taxable gain in the business can be less than if you set up your business as a regular corporation.
• You can declare business losses on your income taxes with an S-Corporation, offsetting your tax liability.
• You can minimize FICA and self-employment taxes. Shareholders’ profits are not taxed in this manner.
• You can raise capital more easily than as a sole proprietor or partnership.
• You have the limited liability protection without paying taxes as a corporation.

Disadvantages of an S-Corporation

However, there are disadvantages:

• S-Corporations cannot have more than one hundred shareholders.
• The company shareholders cannot deduct the cost of fringe benefits provided to employees who own more than 2% of the corporation.
• A shareowner cannot deduct losses more than the amount invested in the company.
• Each S-Corporation shareholder has to be a U.S. permanent resident.
• Profits and losses for an S-Corporation are proportional to each member’s investment into the business.
• You must receive compensation before earnings are distributed to shareholders (i.e., you must pay the employment taxes). This is important when the shareholder is also an employee.

To Form an S-Corporation

The steps for forming the S-Corporation are the same as the regular Corporation (also known as a C-Corp).

The shareholders are required to file IRS Form 2553 found at http://www.irs.gov/pub/irs-pdf/f2553.pdf . This form will transform the corporation into a subchapter S-Corporation.

There may be more steps involved according to your state, consult with your tax professional.

This is only a compilation of information and may not be up-to-date, or apply to your particular situation.