Costs and Drawbacks of an S Corporation: An Introduction

An S corporation suffers from some drawbacks and also causes business owners to incur extra costs. What follows below isn't an exhaustive list of these drawbacks and costs, but it gives you a good starting point:

Bank fees may increase

Bank account fees typically go up for corporate businesses, including the small S corporation. While a sole proprietorship may bank for free, an S corporation typically can't. (Check with your bank for more information about this.)

Extra tax returns

S corporations require an extra tax return --and usually this tax return must be prepared by a CPA, enrolled agent or other tax professional. It's not uncommon to find yourself paying from several hundred to even a few thousand dollars more a year for your S corporation tax returns.

The new S corporation will also now file quarterly and annual payroll tax returns--even if the only employee is the owner. What's more, the new S corporation will need to pay federal unemployment tax on the owner's salary. (This can be as much as $400 annually per owner.)

Restrictions on ownership

An S corporation is restricted in both the type and number of shareholders they have. (In a nutshell, S corporation shareholders need to be either individual U.S. citizens, or permanent residents or something that's closely connected with such an individual taxpayer, such as a testamentary trust or an estate.)

An S corporation may have only one class of stock. You can't, for example, have preferred stock and common stock. And you can't have shareholders whose stock is treated differently. Note that you can have nonvoting stock.

More complicated accounting

S corporations are also required to use some nitpicky tax accounting rules that some other entities aren't subject to. This is pretty obscure stuff, but to give you an idea, an S corporation needs to use a fiscal (accounting) year that ends the last day of September, October, November or December. And an S corporation is limited in the number of shareholders they can have. (The limit on the number of shareholders is currently 100, but you can actually have more than 100 shareholders because some shareholders--like those in a family--are combined when you count shareholders in an S corporation.)

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