When business owners choose an S corp., it’s for the tax benefits. S corps. are more rigid and require more paperwork than LLCs, but they pay significantly less in employment taxes, which makes a big difference for highly profitable businesses. S corps. are beneficial because they:
- Only pay employment tax for employee wages, not their entire net income;
- Can write off certain employee/shareholder benefits for more savings;
- Exist in perpetuity, making it easier to continue operating if a shareholders dies, sells his or her shares, or leaves the corporation;
- Have clearer lines between the business entity and its shareholders;
- Seem more legitimate to investors, who view the corporate structure as more stable; and
- The paperwork resulting from required corporate formalities serves as great evidence of prudent business decisions in the event of a lawsuit
The downsides to S corps. are the restrictions, which include limitations on membership, investments, and types of stock. S corps. must be managed by a board of directors, not the shareholders, and are required to observe corporate formalities. If an S corp. fails to meet all of its entity requirements, it converts to a C corp. and loses its tax benefits.