Is S-Corporation Election Beneficial?

One issue new companies, and sometimes pre-existing ones, face is to select the type of entity they will be registered and taxed as. One of the more popular forms of late is the S Corporation.

Generally, S Corporation election status can be preferential for companies and owners if the company generates profit, as the benefits of not having to pay self-employment tax on the profits and any distributions should equate to tax savings on the individual member returns. If the company does not generate a decent profit, or operates at a loss, the losses allowed to be claimed as deductions are limited by the members’ basis in the company.

S Corporations also have specific requirements that need to be met. Active shareholders will need to be paid a salary equivalent to what individuals in similar positions are paid. If not, any distributions could be noticed by the IRS and subject the company to scrutiny. Upon examination, if it is determined the owners were underpaid; employment taxes in addition to penalties and interest could be applied.

If the company expects to operate at a loss, S Election status may be better off delayed.  Though the losses may be deductible depending on basis, the owners will still have to pay themselves a salary and pay taxes on that salary per S Corporation regulations, taxes that would not otherwise be required if not for the S  election status.

Each member will be responsible for personally maintaining their capital accounts to calculate their basis in the S Corporation at the end of the tax year. It would be beneficial for the S Corp to track the basis to avoid any tax complications in the future, including accrued accounting fees to sort any mess created by not tracking the basis. Also, not tracking the basis for each individual shareholder through out the year could lead to tax complications for each shareholder as stock basis in the S Corporation is used to calculate any capital gains tax on distributions in excess of basis, which deductions may be take, and allowable losses to be claimed.

Whether the S Election status is beneficial for you and your company will depend on your particular set of circumstances. Each company is unique and will have their own issues to consider before deciding whether to  start as an S Corp or late electing to convert to S Election status. The company should always consult with a professional to address all possible tax consequences.