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Level 1

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

Hello, we are still a newer company but have been in business for 4 years, running as a sole prop. Does anyone have some quick dumbed down advice as to why maybe an S-corp would be beneficial to me? 

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Best answer November 16, 2017

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Level 15

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

Here are some basics:

 

The first reason to create any Tax Entity type and stop working under a Sole Proprietorship, comes down to Separation/isolation of risk and protection of assets. As a sole proprietorship, you and your business are the same entity. If you have a legal issue in the business, they are also suing you personally. If you have a private legal issue, they will sue for your business assets, as well.

 

As a Sole Proprietor, you can take any money from the business whenever you want to and that taking is not by itself the taxable event; and even if you don't take any money out, you still report the taxable income and pay income taxes on it. This is called Pass Through Entity. You cannot be on payroll. You are not your own employee.

 

Next, you consider forming an entity.

 

LLC = create a bit of separation from your personal life, by creating an entity for business. This affords you some protection, personally. This is a State and Legal construct. For the Feds, you still would file taxes as a Disregarded Entity = sched C. But now you have a legal entity. Example: In Montana, you buy property and title them to an LLC; you might put up to $5m in one LLC, or one property in each LLC. Now, if one building creates a Risk issue, all of the rest of your properties and your Personal life are protected. They sue the owner of the property = that one LLC. This also is a Pass Through Entity.

 

Now, what happens when Others want to join you? They are partners, or members, of that LLC. You cannot have a Sole Proprietorship with "others" (except under very narrow conditions called Joint Venture). Remember, the LLC will insulate you each from the others' mistakes and their Personal issues, up to a point.

 

Or, you want to elect to be treated as a Corporation. There is C Corp and S Corp. There are Tax regulation advantages to the various entity types. Also, employees start to come into consideration; you can form a corporation and develop a transition plan, so that the employees ultimately own the business when you want to leave.

 

Because under a corporate structure, you are an employee. The US Supreme Court tells us Corporations are their own Persons; you know the corporation cannot do any work. It hires Employees. It is Separate from you. It hires You.

 

For instance, if I have 10 rental properties in 2 LLC, rental income is not the same as Payroll and is not taxed as payroll. If I form an S corp and even am the Sole Shareholder, and then put the property in the name of the S Corp, well, first of all, anyone doing the work of the corporation must be paid through payroll at a Reasonable rate for services performed. You just cranked up the type of taxes to be paid and now you fall under labor laws and employment rules. But, it also opens some other avenues, such as Corporate Owned vehicles.

 

If I ran a tow truck operation, I sure would want to operate as an S Corp and not a Sole Proprietorship. If I owned and managed my own property, I would never use an S Corp structure.

 

An S Corp is a Pass Through Entity, for the Reportable taxable income; this is after payroll is taken as an expense. This tracking and reporting is "by shares owned". If you work harder than I do, and if you and I are 40/60 shareholders, then you get 2/3 of anything I also take from the business as Distribution, which is why Payroll might be a higher Wage rate for you = to compensate.

 

A C Corp pays its own taxes. That results in reportable income to the shareholders who also have tax considerations. That's why you hear the phrase "double taxation" used, and this is why it is in the News right now for Tax reform.

 

No one on the internet can give you more guidance than going to your own CPA and a lawyer. They need to review your business, your financials, your Life, to guide you. And get a second opinion. I have seen many people that were "guided" into forming C Corps, unnecessarily.

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Content Leader

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

Hi there JTcarpentry,

 

I'm glad you turned to us here in the Community for assistance. I'd like to help point you in the right direction.

 

To break it down a little, an S-corp is a corporation with 100 shareholders or less that has met IRS specifications which enables them to be incorporated but to be taxed like a partnership would.

 

I'm unable to advise as to which route would be best for your business so I would suggest consulting with an accountant. They'd be able to tell which option you should go with.

 

I hope you find this helpful. Please let me know if you have any other questions.

 

Highlighted
Level 15

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

Here are some basics:

 

The first reason to create any Tax Entity type and stop working under a Sole Proprietorship, comes down to Separation/isolation of risk and protection of assets. As a sole proprietorship, you and your business are the same entity. If you have a legal issue in the business, they are also suing you personally. If you have a private legal issue, they will sue for your business assets, as well.

 

As a Sole Proprietor, you can take any money from the business whenever you want to and that taking is not by itself the taxable event; and even if you don't take any money out, you still report the taxable income and pay income taxes on it. This is called Pass Through Entity. You cannot be on payroll. You are not your own employee.

 

Next, you consider forming an entity.

 

LLC = create a bit of separation from your personal life, by creating an entity for business. This affords you some protection, personally. This is a State and Legal construct. For the Feds, you still would file taxes as a Disregarded Entity = sched C. But now you have a legal entity. Example: In Montana, you buy property and title them to an LLC; you might put up to $5m in one LLC, or one property in each LLC. Now, if one building creates a Risk issue, all of the rest of your properties and your Personal life are protected. They sue the owner of the property = that one LLC. This also is a Pass Through Entity.

 

Now, what happens when Others want to join you? They are partners, or members, of that LLC. You cannot have a Sole Proprietorship with "others" (except under very narrow conditions called Joint Venture). Remember, the LLC will insulate you each from the others' mistakes and their Personal issues, up to a point.

 

Or, you want to elect to be treated as a Corporation. There is C Corp and S Corp. There are Tax regulation advantages to the various entity types. Also, employees start to come into consideration; you can form a corporation and develop a transition plan, so that the employees ultimately own the business when you want to leave.

 

Because under a corporate structure, you are an employee. The US Supreme Court tells us Corporations are their own Persons; you know the corporation cannot do any work. It hires Employees. It is Separate from you. It hires You.

 

For instance, if I have 10 rental properties in 2 LLC, rental income is not the same as Payroll and is not taxed as payroll. If I form an S corp and even am the Sole Shareholder, and then put the property in the name of the S Corp, well, first of all, anyone doing the work of the corporation must be paid through payroll at a Reasonable rate for services performed. You just cranked up the type of taxes to be paid and now you fall under labor laws and employment rules. But, it also opens some other avenues, such as Corporate Owned vehicles.

 

If I ran a tow truck operation, I sure would want to operate as an S Corp and not a Sole Proprietorship. If I owned and managed my own property, I would never use an S Corp structure.

 

An S Corp is a Pass Through Entity, for the Reportable taxable income; this is after payroll is taken as an expense. This tracking and reporting is "by shares owned". If you work harder than I do, and if you and I are 40/60 shareholders, then you get 2/3 of anything I also take from the business as Distribution, which is why Payroll might be a higher Wage rate for you = to compensate.

 

A C Corp pays its own taxes. That results in reportable income to the shareholders who also have tax considerations. That's why you hear the phrase "double taxation" used, and this is why it is in the News right now for Tax reform.

 

No one on the internet can give you more guidance than going to your own CPA and a lawyer. They need to review your business, your financials, your Life, to guide you. And get a second opinion. I have seen many people that were "guided" into forming C Corps, unnecessarily.

View solution in original post

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Level 15

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

Teach gave you a really good run down, but let me add a couple of issues to the mix.

 

If your state has state income tax, then your states tax treatment of an s-corp is something to consider.  At least one state I know of taxes an s-corp earnings, before it is passed through to the owning shareholders.  Where it is then taxed on their personal state return.

 

Since working shareholders (owners) must be on payroll, that is an added monthly expense, so be sure to factor that in too.

 

The liability protection of an s-corp vs an LLC is basically the same, so though some states allow for an s-corp to also register as an LLC, legally it is useless and is just another cost.

 

An s-corp has the same record keeping requirements as a c-corp, depending on state laws which specify how often, there has to be at least a once a year documented shareholders meeting where major expenses/purchases, distributions, and dividends are approved by shareholder vote (easy vote if you are the only one, but necessary none the less).  The written record gets really important in the event of a law suit, and the courts opinion as to whether or not there is a separation of financial control.

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Level 2

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

A S Corp or LLc protect you against law suits or your business can be suited but your personal property is protected and untouchable. Sole Prop. if you are suited your personal property becomes a part of the law suit.

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Level 15

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?


@Acupuncture4Uwrote:

A S Corp or LLc protect you against law suits or your business can be suited but your personal property is protected and untouchable. Sole Prop. if you are suited your personal property becomes a part of the law suit.


Very true, which is why most sole proprietors and partnerships (which have the same issues) file for LLC (limted Liability Company) with the state.  That filing protects the personal assets too.

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Level 2

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

Personal liability protection same as C corp

"Pass-through" taxation avoids double tax of C

Ability to manage compensation (as long as you meet the IRS's reasonable comp measure) to reduce tax liability from payroll taxes----this is a significant benefit

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Level 5

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

LLC vs Corp is a liability protection decision.  Consult an atty.

LLC vs Corp is not a tax decision.  An LLC is at the state level.  There is no federal tax code for LLC, so you can choose to tax the LLC as a sole proprietor, partnership, S-corp or C-corp depending on the number of members and what you need to accomplish. 

There are no magic tax savings from any entity selection.  Business expenses are always deductible.  Full stop.  Personal expenses are never deductible.  Full stop.  No entity magically changes non-deductible personal expenses into deductible business expenses.  Read this paragraph again.

The ONE exception is that S-corp rules allow business income in excess of "reasonable compensation" to pass through to the owner without  the added social security and medicare tax that attaches to "wages."  So if the business is generating enough CASH to pay a reasonable salary plus taxes, then you can set up the owners on payroll for that reasonable salary and then pass the remaining income to the owners as distributions (subject to income tax, but not SS/Medi). 

There are a few pitfalls to an S-corp, the main one being that all capital and distributions MUST be proportionate  to the members' ownership percentages.  This doesn't always suit the owners' desires.  Running payroll is a hassle.  A lot of owners think this is what they want, then they don't do the work, thereby negating the advantage they wanted. 

Mark Wagner CPA

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Level 8

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

If you are a one-person company, as I am, in some states you don't get to choose, so check that first.  For example, in CA there is no such thing as a one-person LLC, so only choices are C Corp or S Corp, but that works for me so I am an S Corp, which would be my preference.  LLC to me, from accounting view is kinda silly to setup since then most transactions must be processed on your personal books vs. company books that you already have setup for biz.

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Level 15

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?


@Teri wrote:

If you are a one-person company, as I am, in some states you don't get to choose, so check that first.  For example, in CA there is no such thing as a one-person LLC, so only choices are C Corp or S Corp, but that works for me so I am an S Corp, which would be my preference.  LLC to me, from accounting view is kinda silly to setup since then most transactions must be processed on your personal books vs. company books that you already have setup for biz.


Not sure where you got that information, but a sole proprietor in California can file an LLC registration.

https://www.ftb.ca.gov/businesses/Structures/Limited-Liability-Company.shtml

 

goggle it too, there are bunch of sites that will do it for you

 

LLC or not, the books for a sole proprietor are the same. LLC is just a civil legal protection separating your personal assets from the company in the event a law suit goes against you.

 

 ANYONE know why this site is suddenly double spacing?

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Level 8

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

Rustler -

I was answering the question here.  Sole Proprietor vs. S - Corp. benefit, and responded for CA that if you do not want to be a sole proprietor, your other choice is S-Corp since you cannot do LLC as a single owner as I am, and that in my opinion that is preferable to LLC since as an LLC much of the accounting must be done on the personal side, such as payroll and payroll taxes since you can be an employee of an S-Corp but if you are LLC closest you can get is to receive guaranteed payment and then must pay your payroll taxes from your personal bank account vs. company QuickBooks, which to me is more work for the individual to do vs. doing that on company QuickBooks. Do you not agree with that?

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Level 8

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

Mark -

Agree as you said, this is a benefit of S-Corp:

"The ONE exception is that S-corp rules allow business income in excess of "reasonable compensation" to pass through to the owner without  the added social security and medicare tax that attaches to "wages."  So if the business is generating enough CASH to pay a reasonable salary plus taxes, then you can set up the owners on payroll for that reasonable salary and then pass the remaining income to the owners as distributions (subject to income tax, but not SS/Medi)."

IMHO, the benefit above, outweighs the pitfall below, depending on desired preferences:

"There are a few pitfalls to an S-corp, the main one being that all capital and distributions MUST be proportionate to the members' ownership percentages.  This doesn't always suit the owners' desires.  Running payroll is a hassle.  A lot of owners think this is what they want, then they don't do the work, thereby negating the advantage they wanted."  

 

Disagree that running payroll is a hassle, I set mine up in 2015 (on Gusto) auto-pilot and once a year login to add my health insurance paid as imputed income to show on my W-2, which takes maybe 5 minutes and done until next year.  I also record my employer paid SEP/IRA but that is not required, just handy for me to track there. W-2's are automatically submitted to IRS & state. Gusto feeds amounts into my QBO to record those entries.  It can't get much easier than that.

 

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Level 15

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

@Teri

 

Teri I was addressing your flat statement that
in CA there is no such thing as a one-person LLC,

 

CA, allows for an LLC registration for sole proprietors, partnerships and s-corp (though why you would duplicate the legal protection of an s-corp with an LLC filing is beyond me)

Level 8

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

Yes, sorry about that.  I do not work with any sole-proprietors and my business is not sole proprietor and I understood this person to be looking to understand the alternatives to being sole-proprietor. 

 

In other words, assumed he was considering LLC or S-Corp, where I would recommend S-Corp for the reasons mentioned.  I was a sole-proprietor 10 years ago when I started but am an S-Corp now.

 

I have clients who are LLC, but file taxes as an S-Corp.  In fact, all my clients do S-Corp or C-Corp.  

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Level 8

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

Also, not sure why this is double spacing, but see what you mean, since my post just did that too.

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Level 1

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

Hi Mark,

 

My question my client is a LLC with an EIN my clients has eclected to become a S-Corp, can use the client company or do I need to set up a new company file. I was told by the attorney the client could use the same EIN ?

  Christopher F. Verone

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Level 10

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?


@cfvbookkeeping wrote:

Hi Mark,

 

My question my client is a LLC with an EIN my clients has eclected to become a S-Corp, can use the client company or do I need to set up a new company file. I was told by the attorney the client could use the same EIN ?

  Christopher F. Verone


I would think the creation a new corporation requires new EIN and a new set of books. The activity of the LLC is not the history of the new corp

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Level 8

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

Did he actually setup a new S Corp, or did he just elect to be taxed as an S Corp by filing IRS form?

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Level 1

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

Hi Teri,

 

The client is a LLC, We will be filing form 2553, her attorney said she will not need a new ENI. 

In this case she elected to be taxed as a S-Corp.

 

 

 

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Level 8

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

Excellent!  I would agree in that case.   Never really got the LLC thing unless you wanted partners.  

Highlighted
Level 15

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

If you don't want to ask your own CPA, then you can use the Web Resources for these questions. It's right here:

https://www.irs.gov/businesses/small-businesses-self-employed/do-you-need-a-new-ein

 

You will not be required to obtain a new EIN if any of the following statements are true.

  • You report income tax as a branch or division of a corporation or other entity, and the LLC has no employees or excise tax liability.
  • An existing partnership converts to an LLC classified as a partnership.
  • The LLC name or location changes.
  • An LLC that already has an EIN chooses to be taxed as a corporation or as an S corporation.
  • A new LLC with one owner (single member LLC) is formed under state law, does not choose to be taxed as a corporation or S corporation, and has no employees or excise tax liability. NOTE: You may request an EIN for banking or state tax purposes, but an EIN is not required for federal tax purposes.
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Level 8

Sole Prop VS. S-Corp -- Why might an S-corp would be beneficial to me?

Makes sense, always good to know my guess would be correct. I do not work with any LLC's who do not file taxes as an S Corp.  Seems silly to have most of your accounting done outside of business. 

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