There are many benefits of this entity status. One of the largest benefits Is no double taxation. The shareholders are only taxed at the shareholder level. Also, unlike a partnership, where all the partners are subject to self-employment tax on income from the firm, only wages earned are subject to a self-employment tax in an S corporation. In an S corporation shareholders may be employees, and the wages paid are deductible from the net income but are also subject to payroll taxes and therefore you may be inclined to pay lower wages to void this tax.
Keep in mind though, that if you understate your wages from normal industry salaries the IRS may require you to pay higher salaries relative to the industry and position. Nevertheless, if prepared properly, this rule should only be beneficial. Another large benefit of the S Corporation status Is that it stands alone separate from Its shareholders. If any of you decide to leave the company for any reason, then the company can continue to run Its dally business without much Interruption.
The shareholders receive their pro rate share of profits and pay tax based on their personal income tax rates, although actual cash distribution is irrelevant when defining your taxable income. Moreover, loses from the firm are deductible to the extent of your investment. Furthermore, if ever the firm cannot pay its debts, any creditors would have no claim against your personal assets. Unfortunately, there are disadvantages as well. For instance, if one of you decides to sell your portion to an ineligible S Corporation shareholder, the entity status is ruminated immediately and subject to double taxation.
Given this harsh outcome, the law allows the current shareholders to take proper recourse in buying back the stock, and thus keeping their S corporation status. Ineligible shareholders refer to the strict illegibility of an S corporation shareholder. Only Individuals, certain trusts, estates, and tax-exempt organizations are eligible to be shareholders. This rule Is In place for shareholders to be taxed at their Individual rates. In addition, the number of shareholders is limited to one hundred.
While both these restrictions could be a burden onto your company given the current business plan. Additionally, unlike a partnership, an S corporation cannot allocate different amounts of income at their discretion. The income is allocated based on the percentage of owned outstanding stock in the company. So while you all are planning to contribute the same amount of money, perhaps you would consider that Moe and Larry contribute a slightly larger initial investment than Curly given they will be working more with the business at the ginning stage.
Moe and Larry may feel they should be compensated more for their time, thus requiring a higher percentage of profits. Conversely, Moe and Larry can receive higher wages from the company. Given your specific strategy you should undoubtedly be able to find a suitable buyer when the time comes for an exit. Also if one of you decides to leave the firm, the other two may buy that partner out. I am confident about this selection and look forward to working together. Sincerely, CEO, Leadenness Consulting Inc.
