Starting an S-Corp, we have an investor, what do I have to lose?

Question

My friend has an idea for a business. He asked me to join him and 3 other guys to establish an S-Corp. They just found an investor for our start up costs of $600,000. Each of us has a certain job description mine is basically Head of tech and hardware, which is why im asking for help here. The guy thats handling business and finance estimated our annual profit of about $1000000.He also says he needs money from everyone to start the S-Corp($40/partner). My question is what if we don't even break even? Do we (us 5 guys) lose any money from our own pockets? Can someone explain how profits and loses "pass through" our personal income taxes and what other taxes and forms are involved for just shareholders not the corp itself? Im just hesitant because I heard that some shareholders get taxed on money they don't even receive and I trust some of these guys.

Answer 1

First of all "Breaking even" has to do with cash flow  -- not profits and losses.  A business that is breaking even has as much or more cash coming in as it does going out.

Profits and losses may or may not coincide with cash flow.  In other words it is not at all unusual for a growing business to be profitable but have a negative cash flow due to the need to invest in machinery and equipment.  

Now, in a S-corp the profits/losses are not taxed at the corporate level but are passes on the the shareholders in proportion to their ownership.  The individual shareholders are then responsible for the taxes on their share of the profits.

The "Catch 22" is that if the profits are substantially larger than your cash income the shareholders could find themselves paying taxes on the profits even though they did not receive any cash from the S-corp.

I know that everyone wants to beat corporate taxes and everyone seems to love S-Corps and LLCs, but if you are starting up a company with the intention of going public and /or will be seeking additional investors in the future I think you will be better off just going with a conventional corporation.

Hope this helps

Jerry-the-bookkeeper

Answer 2

this is a big group of questions. My best advise is to find a tax accountant in your area and sit down with them and ask all theses questions.That's what I do for a living, DO NOT try to get theses answers here,as some of the advise may be wrong or just wrong for your circumstance.A little money spent now with reap benefits for you in the future.