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Pros and Cons of S Corporations

November 20, 2023

S Corporation is the most common form of doing business except for the unincorporated sole proprietorship. S Corporation is especially popular among small businesses. The number of S Corporations has increased over the years. However, there are pros and cons to operating your business as an S Corporation. Here is a checklist highlighting advantages and disadvantages of the S Corporation form.


  • Your personal assets will not be at risk because of the activities or liabilities of the S Corporation (unless you pledge assets or personally guarantee the corporation's debt).

  • Your S Corporation generally will not have to pay corporate level income tax. Instead, the corporation's gains, losses, deductions, and credits are passed through to you and any other shareholders, and are claimed on your individual returns. The fact that losses can be claimed on the shareholders' individual returns can be a big advantage over regular corporations. However, this is subject to the passive loss limits -- S Corporations pay tax at the highest corporate rate on their excess passive income. Liquidating distributions generally also are subject to only one level.

  • FICA tax is not owed on the regular business earnings of the corporation. It is only taxed on salaries paid to employees. This is a potential advantage over sole proprietorships, partnerships, and limited liability companies.

  • The S Corporation is not subject to the so-called accumulated earnings tax that applies to regular corporations that do not distribute their earnings and have no plan for their use by the corporation. S Corporation does not risk being characterized as a personal holding company because of its pass-through nature do.

  • Your income from the corporation may qualify for the 20% deduction for qualified business income.


  • S Corporations cannot have more than 100 shareholders (a married couple treated as only one shareholder). Further, no shareholder may be a nonresident alien.

  • Corporations, nonresident aliens, and most estates and trusts cannot be S Corporation shareholders. Electing small business trusts (ESBTs), however, can be shareholders.

  • An S Corporations may not own another S Corporation unless the subsidiary is a Qualified Subchapter S Subsidiary (a 100% owned S Corporation or QSub). This can make expansion difficult. Termination of the QSub's status can be treated as a sale of assets.

  • S Corporations can have only one class of stock (differences in voting rights are permitted, and bank director stock is not treated as a separate class of stock). This severely limits how income and losses of the corporation can be allocated among shareholders. It also can impair the corporation's ability to raise capital.

  • A shareholder's basis in the corporation does not include any of the corporation's debt, even if the shareholder has personally guaranteed it. This has the effect of limiting the amount of losses that can be passed through. It is a disadvantage compared to partnerships and limited liability companies, and is one of the main reasons that those forms are usually used for real estate ventures and other highly-leveraged enterprises.

  • S Corporation shareholder-employees with more than a 2-percent ownership interest are not entitled to most tax-favored fringe benefits that are available to employees or regular corporations.

  • S Corporations generally must operate on a calendar year.

  • An S Corporation may be liable for a tax on its built-in gains, if, among other things, it was a C corporation prior to making its S Corporation election.

  • Your income from the corporation is taxed at your individual income tax rate. It does not qualify for the 21% corporate tax rate.

It would be highly recommended that your situation should be fully evaluated before choosing to operate your business as S Corporation.


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