Some S Corporation Disadvantages
Posted: Thursday, January 28, 2010
by Stephen Nelson
Stephen L. Nelson, CPA
Electing S corporation status delivers many benefits to the small business owner, including lower taxes. But S corporation disadvantages do exist... Ponder, for instance, the following:
S Corporation Tax Returns
An S corporation requires its owners to prepare and submit an additional federal income tax return for the corporation. In most states, a state corporate tax return is also required. The S corporation tax return isn't very difficult. But the return is beyond the scope of most small business owners and in-house bookkeepers to prepare. Accordingly, one obvious S corporation disadvantage is the extra cost and headache of having someone like a CPA prepare your business tax return.
A one-person business in which only the owner works doesn't require payroll accounting or payroll tax returns. However, if the same one-person business incorporates, the business needs to start doing formal payroll. Payroll accounting isn't that complicated. But it does take extra bookkeeping time. And note that the first employee you add to a business typically requires filing an additional one to two dozen payroll tax returns each year: quarterly federal payroll returns, quarterly state payroll returns, quarterly workers compensation returns, annual federal unemployment tax returns, W-2s at the end of the year, and so on.
Extra Payroll Taxes
S corporations typically save their business owners payroll taxes. Be aware, however, that incorporation also normally triggers extra payroll taxes, too. For instance, the $434 per employee federal unemployment tax must be paid on anybody making more than $7,000 a year (unless you're paying state unemployment taxes for the person). You may, in certain states, also be expected to pay extra payroll taxes on shareholder-employees for unemployment insurance, industrial accident insurance, worker training programs and whatever additional tax program the local state government has decided applies.
S Corporation Liquidation Taxes
One final disadvantage to the S corporation option should be mentioned. If you need to liquidate an S corporation, you may be subject to tax on the imputed gain you enjoy when you shut down the corporation. For example, if you purchase some item of equipment for $100,000, fully depreciate the item, and then give the equipment to the owner at liquidation when the equipment has $10,000 of value, you'll be taxed on the $10,000 of value. Triggering tax at a liquidation sometimes isn't a very big problem when you're talking about furniture and fixtures. But if the S corporation holds appreciated assets (like real estate) the tax bit can be pretty painful. For example, liquidating an S corporation that owned a building that's appreciated in value can be a killer.
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Seattle CPA Stephen L. Nelson specializes in S corporations. He's also the publisher of the S corporation explained web site and the author of the S corporation disadvantages page at the S Corporations Explained website.
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