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Tax Disadvantages of S Corporations

S corporations are less flexible than partnerships in terms of allocating profits and expenses for tax advantages. Also, if an S corporation liquidates an asset, it can result in taxable gain for its shareholders.

Other issues associated with S corporations that give rise to tax disadvantages include the following:

  • Accounting: Accounting rules that apply to S corporations can be extremely complex which can result in higher accounting and tax preparation fees for S corporations
  • Complex tax preparation: Tax preparations and filing become complicated when an S corporation has out-of-state shareholders or conducts business in multiple states. Shareholders who live in states other than the one in which the corporation is located must file tax returns in their home states, as well as filing in the state or states in which the business is located. If an S corporation conducts business in multiple states, each shareholder may have to file tax returns to each of the states in which the corporation does business
  • Minimum tax: Tax preference items reported on shareholders’ personal income tax returns can trigger an unexpected minimum tax problem for some.
  • Recognition: Not all states recognize the S corporation as a legitimate business entity
  • Salaries for shareholders: The IRS watches closely the salaries of shareholder-employees. If warranted, it may claim that the corporation is underpaying its shareholders to save in paying FICA taxes

Inside Tax Disadvantages of S Corporations