Thinking about switching your business to an S corporation?
In Texas, S corp status is a tax-friendly option that many small business owners at least look into because it can reduce self-employment taxes when set up correctly.
Texas has no personal income tax and a relatively friendly franchise-tax threshold, which makes the structure especially appealing to owners of small businesses.
Yet, at the same time, plenty of owners don’t actually elect S corp status because of the added rules and costs. Read on as we go over the disadvantages of an S Corporation so you can easily decide if it suits you.
An S corp is still a corporation. That means more rules and more forms than a simple sole proprietor or single-member LLC.
You’ll need to file a special small-business tax return with the IRS each year, instead of just adding it to your personal tax return. You also need to give each owner a summary of the profits or losses they’ll need to report on their personal taxes. Then, there’s also the basic corporate records you need to keep, like noting big decisions in writing.
This isn’t hard, but it’s extra time and extra fees from your bookkeeper or CPA.
Many owners like S corps because you can take part of your profits as owner distributions that aren’t hit with payroll taxes. But the IRS requires you to pay yourself a fair salary first, and they watch this closely.
If you underpay yourself, they can reclassify your distributions as wages after the fact and bill you for back payroll taxes and penalties.
With an S corp, profits have to be split based on ownership percentage. If you own 60% and your partner owns 40%, that’s exactly how the profits and losses must be divided.
You can’t give someone a bigger cut just because they brought in more business, unless you change the ownership percentages. LLCs taxed as partnerships are more flexible that way.
S corp has strict limits. No more than 100 owners, no foreign owners, and only one type of stock. That’s fine for a one- or two-owner business, but it can be a problem if you plan to raise money or bring in outside investors later.
Even though S corp don’t pay federal corporate income tax, states treat them differently. Texas has no personal income tax, which is good, but you may still owe Texas franchise tax or other fees. If you do business in other states, their rules can shrink or wipe out the savings you thought you’d get.
Your future Social Security benefits and how much you can put into retirement plans are based on your W-2 wages. So are a lot of lenders’ income calculations. If you keep your salary very low to save on taxes, you may hurt your retirement savings or make it harder to qualify for a mortgage.
Due to the payroll requirements and separate tax return, most S corps pay more for bookkeeping, payroll, and tax prep. Those costs can eat into or even cancel out the payroll-tax savings you were aiming for.
Despite the challenges, S corps are a great answer for many small businesses. If you’re unsure, let’s run the numbers for you.
We work with small businesses in Fort Worth on effective tax strategies to keep more of your hard-earned money in your pocket.
Book a time with us and let our team of experts advise on whether an S-corp makes sense for you.
