Disadvantages of S Corporations

Many people set up S corporations to avoid the 15.3% self employment tax incurred by partners and sole proprietors on their net income. The IRS knows this and subjects W-2 wages of Sub S shareholders to greater scrutiny the lower they are so that strategy may not work.  The IRS says that W-2 wages must be reasonable. Another problem with lower Sub S shareholder W-2 wages is that it reduces your social security benefits when you retire since the calculation is based on your highest 35 years of self employment income and W-2 wages. Also distributions to shareholders have to be proportional to their stock ownership which may be difficult with unrelated shareholders.