I love S corporations. I really do. And the reason is simple: An S corporation often saves small business owners substantial payroll and corporation income taxes.
Unfortunately, an S corporation disadvantages its owners with several problems (as explained in the following paragraphs) and smart business owners and entrepreneurs will consider these drawbacks before setting up an S corporation.
One S Corporation Disadvantage is More Complex Accounting
A first quick point: Typically, an S corporation requires more accounting. For example, an S corp will often be required to include balance sheets (also known as statements of financial condition) with its annual S corporation tax return.
Note: Balance sheets appear on page 4 of the S corporation tax return in Schedule L.
This extra financial record-keeping disadvantage may mean you require additional outside bookkeeping help. You may also need to begin using full-fledged business accounting software.
S Corporation Tax Returns Increase Preparation Costs
Another S corporation disadvantage or drawback: S corporation tax returns usually cost considerably more to prepare. This extra cost makes total sense, by the way. A corporate return is more complex. And an S corporation return includes many additional pages with special worksheets and supplemental schedules.
Accordingly, while you may be comfortable doing your own sole proprietorship tax returns by hand or with TurboTax, you’re probably not going to be able to do that with an S corporation. You’re probably going to have to pay a CPA or enrolled agent to do the tax return???and that will increase your costs.
Note: The S corporation 1120S tax return form can be downloaded for free from the Internal Revenue Service’s web site, irs dot gov. Check out the 1120S tax return if you want to get a feel for the S corp tax return’s complexity.
S Corporation Shareholder Payroll Jacks Risks and Expenses
One final important point to consider concerning the S corporation’s disadvantages and drawbacks: S corporation status may be the event that triggers a requirement that you begin preparing formal payroll checks and returns.
The S corporation status triggers payroll, by the way, when only the owner or the owners work in the business. In other words, if the only workers in a sole proprietorship or partnership are owners, the business doesn’t need to do payroll. But if the proprietorship or partnership reforms as an S corporation, even though it hasn’t hired any non-owner workers, the business must pay the owner-employee(s) a reasonable wage. And that means the entity needs to prepare formal payroll checks and returns.
Payroll checks and returns require time to prepare. And payroll processing typically increases your payroll taxes because federal and state governments levy additional (often hidden) payroll taxes on employers.
Note: If you already employ non-owners, you’re already procssing payroll and the extra time required for owner-employees will be modest.
About the Author: CPA Stephen L. Nelson regularly speaks and writes about the Subchapter S corporation option. For more information about the disadvantages of an S corporation, see http://www.scorporationsexplained.com/scorporation-advantage-disadvantage.htm