There are generally three types of business forms from which to choose when starting a new company. The sole proprietorship gives unlimited liability to its owner in which the personal wealth of the owner is in jeopardy if the business runs into trouble. Money from a sole proprietorship is simply taxed as income on the owner’s personal income tax. A partnership is similar to a sole proprietorship except multiple owners have a claim to the organization. General partnerships also carry unlimited liability to the owners even if just one of the owners acts in the interests of the others. Unfortunately, partnerships are often dissolved when one of the owners dies. This impermanency is one reason why a corporation may be a better choice in some situations.
The corporation enjoys four main benefits over the other organization forms. These benefits include limited liability for the owners, permanency, the ability to transfer ownership to other parties, and access to capital stemming from the permanency of the firm. However, sometimes a normal corporation is too complicated for a small business and yet a partnership is too inflexible to meet the needs of the organization. The S Corporation, which conceptually lies between a partnership and a corporation, can be the solution to this problem.
Under the U.S. Code Title 26 Subtitle A Chapter 1 Subchapter S Part 1 § 1361, an S corporation is defined as:
For purposes of this title, the term “S corporation” means, with respect to any taxable year, a small business corporation for which an election under section 1362 (a) is in effect for such year.
Section 1362 of the code states that a small business corporation may elect to become an S corporation if all shareholders consent to the election. Like a corporation, owners of an S corporation enjoy limited liability from creditors so that the personal wealth of the owners is not in jeopardy should the company default on an obligation. However unlike a corporation, income from operations is not taxed at the corporation level but is taxed as personal income on the owners’ own personal income tax. One of the disadvantages of a corporation is that income is taxed twice. Since the corporation is considered an entity like a person, its income is taxed at the corporate level and then the income of the owners is taxed on their personal income taxes. An S corporation avoids taxation at the corporate level just like a general partnership.
So with all these benefits, why would you ever not choose S Corporation status?