S-Corps, or “Small Business Corporations,” are a popular entity structure for tax purposes. In fact, they surged in popularity during the Covid era, partly fueled by “experts” on TikTok and YouTube. (Pro tip: Don’t rely on social media for your tax advice!)

While S-Corps can be useful in certain circumstances, the structure comes with complexities and potential pitfalls that make it a poor fit for many small business owners. Let’s walk through a few of the common problem areas:

Payroll Requirements

If you own an S-Corp, you must take a paycheck and file a W-2 for yourself. This isn’t optional. Failing to do so can result in penalties and unexpected tax bills.

Loan and Basis Complications

Borrowing money through an S-Corp isn’t straightforward. A simple loan can create “phantom income” — profits that appear on paper but doesn’t actually put cash in your pocket, and yet you still owe taxes on them.

On top of that, the IRS’s “tax basis” rules — essentially tracking how much you’ve invested in the company — are notoriously complicated. Even small errors in basis calculations can trigger expensive consequences.

Why I Prefer LLCs for Many Clients

Because of these traps, S-Corps often require a high level of diligence and compliance that most small businesses find burdensome. That’s why I often recommend LLCs instead.

LLCs are supported by strong, flexible state laws (including here in Alabama) and are much more forgiving of honest mistakes. They also provide unmatched flexibility in tax planning: an LLC can be taxed as a sole proprietorship, a partnership, or even as a corporation, depending on what best fits the owner’s goals.

This flexibility, combined with simpler compliance, often makes LLCs a safer and smarter choice for long-term planning.