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If you are operating as a Sole Proprietor or General Partnership, you may consider forming an S-Corporation. Those entity structures do not provide asset protection, and you could lose your personal possessions if your business is sued. The S-Corporation still provides limited liability protection and is a good entity for many business situations, especially if you are providing a service, such as consulting, to the general public. 

  General Description of an S-Corporation

The S-Corp (so named from a chapter of the tax code) is a tax device created by federal law in 1958. It is a regular corporation with regular limited liability under state law, whose owners elect pass through status for federal tax purposes. That status requires compliance with a number of often constricting rules but, with some exceptions, complying corporations escape federal corporate tax. As regular business S-corporations under state law, they may be taxed under state tax law as regular corporations, or in some other way. Corporations whose owners don't choose to make the federal S-corp election are called C-corps (after another chapter of the tax code).

Caution: Limited liability comes at a cost, however, since states may impose a tax on S-corps not imposed on entities with unlimited liability.

S-corps are subject to a number of significant rules and restrictions:

  • All owners must agree to S-corp status. This means that one co-owner can exact a price or impose conditions for his or her agreement.

  • An S-corp can have only one class of stock, which means that income, losses and other tax attributes are allotted among stockholders in proportion to stock ownership.

  • The number of co-owners is limited (to 100, with qualifications, counting members of the same family as one stockholder).

  • There are limitations as to who can be co-owners (for example, a nonresident alien cannot) and as to the kind of business that can qualify for as an S-corp (for example, an insurance company cannot).

Caution: Failure to meet, or ceasing to meet, these requirements means loss of S status and conversion to C-corp status and C-corp taxes.

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  • Limited liability for shareholders and management.

  • Courts recognized existence, which helps protect you from personal liability that can cause you to lose your personal wealth in assets like your home, car, or nest egg.

  • Flow-through taxation: Profits are distributed to the shareholders, who are taxed on profits at their personal level.

  • Great for splitting income for the owners. The Owners and/or Shareholders can take a smaller salary and pay income taxes and regular payroll deductions, then take the remainder of profit as a distribution subject to income tax only.

  • S Corporations are great for businesses that provide services to avoid being classified as a Personal Service Corporation by the IRS and being subject to an increased PSC tax rate.

  • S Corporations do not have significant start-up costs;​


  • Maximum of 100 shareholders, all of whom must be U.S. residents or resident aliens

  • At shareholder level, shares are subject to seizure and sale in court proceedings.

  • Owner/employees holding 2% or more of the company’s shares cannot receive tax-free benefits.

  • Because flow-through taxes will be paid at the personal rate, high-income shareholders will pay more taxes on their distributions.

  • Not suitable to hold appreciating investment. Capital gain on sale of assets will incur higher taxes than with other pass-through entities such as LLCs ad Limited Partnerships.

  • Limited to one class of stock only.

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