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What are the pros and cons of a sub S corporation?

A sub S corporation, or subchapter S corporation, is a special type of corporation that provides the security of LLCs but allows profits and losses to flow directly through to shareholders. This means that income and losses accrued by the corporation may pass through to the shareholders so that they may include them on their individual tax returns. This eliminates the need for the company to pay federal taxes. Though this type of business entity is more appealing to small business owners than a standard corporation, you should weigh the pros and cons of this type of entity before structuring your Illinois- or Michigan-based business around it.

According to Entrepreneur, there are a few benefits of electing to form a subchapter S. One is that you can use the cash method of accounting. The cash method is simpler than the standard accrual method as it allows you to tax your income as you receive it and deduct expenses when you pay them. Another benefit is that you assume limited liability for items such as debts and claims against your business, much as you can do with an LLC. 

The stock of S corporations is also freely transferable, which means you can sell your shares without having to obtain approval from other shareholders. If you were to form an LLC, you would need the approval of other members before you could sell. Another advantage of forming an S corporation over an LLC is that you alone may form the entity, whereas an LLC requires two people.

A subchapter corporation does not come without its pitfalls, however. If you form an S corporation, you may only elect up to 75 shareholders. The law limits the type of entities that may be shareholders of an S corporation to individuals, tax-exempt charitable organizations, certain trusts, estates, certain partnerships and other S corporations. LLCs can have an unlimited number of owners.

Additionally, S corporations are subject to many of the same requirements by which corporations must abide. That means S corps must hold director and shareholder meetings, keep meeting minutes, file articles of incorporation and allow shareholders to vote on major decisions. These requirements mean increased legal and tax service costs.

Filing deadlines are strict with S corporations. You must make the subchapter S designation within two months and 15 days of the first of the tax year. If you fail to do so, the state may revoke your S status, in which case the IRS would tax your business as a corporation.

Finally, S corporations cannot have non-U.S. citizen shareholders. LLCs can.

The information in this post is strictly for educational purposes. It should not be construed as legal advice.