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Are S-Corps on Their Way Out?

tax due dateWhat is an “S-Corp”? 

An “S Corp”, also known as a subchapter or small business corporation was created in 1958. The political premise was that it was going to encourage and support the creation of small businesses while eliminating the double taxation that conventional corporations were subjected to.

Before the S-Corp

S-Corps were born because of an economic disparity between big business (C-Corps) and small businesses (Sole Proprietors and Partnerships). C-Corporations provided legal liability protection but paid tax on net profits with the shareholders paying an additional tax on dividend distributions. This is what they call double taxation. 

Proprietorships did not enjoy the legal protection a C-Corporation provided and were subject to individual tax and social security tax. This is why the tax structure was unfair. 

This economic formula resulted in small businesses staying small and C-Corporations growing in size and power. Only larger businesses with investors could do business as a C-Corp, leaving profits in the company to grow and increase in value. The investors in C-Corps enjoyed an increase in net worth without paying taxes on their increasing wealth. Investors only pay taxes on dividend distributions but not on a stock increased value unless they sell it. Wealthy investors are more interested in increasing value rather than dividend distributions. This resulted in an unbalanced concentration of wealth and wealth in the United States is Power.

In 1956 the Democratic Congress starting putting pressure on then-President Dwight Eisenhower claiming he favored the interests of big business over small business. The powerful vs the less powerful. The bill creating the S-Corp was signed by President Eisenhower in 1958. 

The strategy was to eliminate double taxation while providing the same limited legal liability corporations enjoyed. The S-Corp was created to encourage the creation of family-owned and small businesses. The United States only hope for an innovative business environment among small businesses. 

THE RESULT OF THE LAW

If the objective of creating S-Corporations was to level the playing field it has not come close to realizing its objective. I base my conclusion on the simple fact that over the 60 years of S-Corp Existence unincorporated entities outnumber their corporate counterparts by over 20,000,000 to less than 5,000,000 S-Corps.

DATE #OF BUSINESSES #OF C-CORPS #OF S-CORPS #OF PROPRIETORSHIPS INCREASE IN CORPS INCREASE IN PROPRIETORSHIPS
1958 6.1m .7m ? 5.4m - -
1965 11.5M 1.4 .7m? 9.8m .7m 4.4m
1980 14.3m 2.7m 1.35m? 12.3m .65m 2.5m
1990 20.0m 3.7m 1.85m? 16.2m .5m 3.9m
1995 22.4m 4.4m 2.2m? 18m .35m 1.8m
2005 27.9 m 5.8 m 2.9? 24.5m .5m 6.5m
2016 31.4m 5.6m 2.3m?   24.8m  -.6m .3m
TOTAL INCREASE 4.9m 19.4m

DATA SOURCE: 1958-2005 US CENSUS/ 2016 www.statistica.com

The 1st thing I’d like to point out is that finding the numbers to fill this chart has been a monumental task. Not that there’s a lack of statistics but the fact that there are few reliable statistics. I went to the only source that had any kind of consistency in the numbers to make an honest comparison, The US Census. Even that was a challenge because of the way they count partnerships and sole proprietors. I have combined them since both share the same major tax issue-the self-employment tax. When you think about it, it’s like a tax for not being an employee. Employees pay half of what self-employed, unincorporated individuals pay.

The other fact is that there are no hard facts on the number of S-Corps other than bit’s of information released by the IRS and those numbers can not really be verified. Statistics provided by the SBA are suspect because there is nothing to gain and everything to lose by highlighting the biggest problem American business owners face which is that doing business as a sole proprietor is the single biggest mistake a serious business owner can make.

If you look at the totals-understanding that even with admittedly suspect numbers the results are obvious. In the 58 years covered by the chart above, there has been an increase in the # of businesses of 23.4 million. Of the increase, only 4.9 million are corporations and 19.4 being proprietorships. Since C-Corps are included in that figure we don’t even have the number of S-Corps but even combining them shows the complete failure of “leveling the playing field” the S-Corp was supposed to accomplish. 

The fact is that if the real intention of creating the S-Corp was to level the playing field it’s obvious from the numbers it has not worked and the reason for that is very simple-Social Security taxes. Proprietors pay self-employment taxes on net profits while S-Corps pay none.

Knowing that being a sole-proprietor or even a partnership is a bad way to do business I had to ask myself why there is such a lack of government information on how bad it is. I mean, they give us bad information on everything including alcohol, smoking, what we eat and drink ect... Just Google “harmful effects” of anything.

Nothing from SBA or any other government agency other than “Sole proprietor is the simplest form of doing business” Nothing on paying self-employment tax or the fact that they get audited more and have little legal protection. They do mention how much more complicated and expensive it is to set up a corporation and they are correct about that but when you are talking about a single shareholder S-Corp the cost is much less $1,000 and then corporate governance is minimal. The tax saving each year far outweigh the cost of getting an S-Corp set up.

They focus on how complicated it is to keep meeting minutes and having a board of directors votes. In other words, when there is 1 shareholder who is also the President and Secretary as well as the only board member, it’s too complicated to have one of those meetings, vote on it and have it documented. What nonsense!!!! 

The fact is that the ramifications not documenting it are……???? What? Very, very, very, very little, if any. In fact, in over 35 years in business I have never ever seen it come up one time. Remember, not only have I worked with thousands of small businesses directly, I worked at and helped manage over 20 CPA firms in one capacity or another easily representing hundreds of thousands of businesses. You would think that if it were a real issue I would have come across at least one instance of it being a problem. But what if it were? 

There is very little you would need to document a board meeting. The truth is that you are documenting a decision that you made on behalf of the corporation as its president and you, as the only board member is approving it. What nonsense. It’s all miss-information all for the non-promotion of the S-Corp.

Let’s get back to the social security issue which is the main reason why the USA never promoted S-Corp ownership. Net profits of sole proprietors are subject to self-employment taxes while there is zero self-employment tax for S-Corps on net profits. If millions of sole proprietors converted to S-Corp status the social security system would collapse 40 years before it’s projected to. 

S-Corps have not “leveled the playing field” as politicians have promised. They probably realized what a total disaster it would have on their careers. Social Security is a no-win situation for politicians so they just keep kicking the can down the road to let future politicians deal with it. Why accelerate the issue by draining social security faster? 

That’s why there have been attempts to add social security taxes to S-Corp profits for the past 20 years. The information below is from www.s-corp.org who is one of the only S-Corp champions out there.

Blocked $9 Billion Payroll Tax Hike on S Corporations, Again (2012)

Blocked $11 Billion Payroll Tax Hike on S Corporations (2010)

Blocked Attempts to Increase Payroll Taxes on S Corporations (2005)

In conclusion, I believe that the tremendous advantages of S-Corp ownership will eventually be snatched from us. Unfortunately, it’s the same old battle between the rich and powerful and the small guy. The same issues there were in 1958 still exist today. More than 3,000,000 businesses fail each year and it’s directly related to choosing to stay a sole proprietor rather than choosing the more logical S-Corporation. The concentration of wealth and power vs 25,000,000 sole proprietors that find out they made a fatal mistake-staying a sole proprietor.