When you’re setting up or changing the structure of your business, there is a lot to think about.
Do I Need An LLC? What Are The Options?
There are many forms of business structure to chose from, such as:
- Sole Proprietorships & General Partnerships
- Limited Liability Companies (LLCs)
- LLC with S-Corp Tax Election
In our first installment we looked at sole proprietorships and general partnerships. In the second installment we considered LLCs, themselves. Today we’ll wrap up this series with a look at S-Corps and C-Corps.
An S-Corp is a corporation that has obtained the s-chapter designation from the IRS. An S-Corp has many of the same tax implications as an LLC but requires the more burdensome start up and maintenance of a traditional corporation.
The IRS considers an S-Corp to be separate and apart from its shareholders (AKA owners) (which is true of an LLC as well) and allows pass-through taxation, so the corporation itself is not taxed. The owner-employees are required to pay themselves fair market or reasonable compensation from the profits. If the owner-wage is not reasonable the IRS could re-classify all additional corporate earnings as “wages.”
The biggest S-Corp benefit is the tax benefits. The downside is that if a shareholder owns more than 2%, any benefits such as health and life insurance are considered taxable income.
An S-Corp maintains the business a little more clearly separate from the owners, making deaths or departures of shareholders less bothersome to the running of the business and improves the protection of remaining shareholders.
This protection comes at a price. S-Corps require scheduled director and shareholder meetings, minutes maintained, adoption and updates to by-laws, stock transfers, and records maintenance, and additional IRS forms such as Form 1120S: income tax Return for S Corporation, 1120Sk-1: Shareholder’s Share of Income, Credit, Deductions, Form 4625 Depreciation, Employment Tax Forms, Form 1040 Individual Income Tax Return, Schedule E: Supplemental Income and Loss, Schedule SE: Self-Employment Tax, Form 1040-ES: Estimated Taxes for Individuals, Forms 2553, 941, and 940. The forms are due at varying times in the tax year, making the tax documentation burden much higher than an LLC structure.
LLC w/ S-Corp Tax Election
The best of both worlds – a Limited Liability Company legal structure (easier!) with the tax benefits of an S-Corp election! You must use Form 2553 to elect an S-Corp taxation structure within the first two moths and 15 days of the taxation year.
This is your traditional corporation with all the legal burdens and responsibilities of the formation and maintenance of the business entity and none of the tax benefits. Corporation is considered a totally separate tax entity that reports its own net income and losses, pays its own taxes, distributes profits to shareholders, files its own return.
The profit of a corporation is taxed to the corporation when earned and then is taxed to the shareholders when distributed as dividends. This creates a double tax. This makes sense for large corporations, but no sense at all for small businesses. The corporation pays a tax and then the owner pays a tax again!
Talk To Your Lawyer & Accountant
Consult with your lawyer and your accountant. They have worked with many business owners and have a good idea of what can happen and how to forestall the worst consequences. An ounce of prevention is worth a pound of cure, as the saying goes, and it couldn’t be more true than in this context!
In addition to formation, dissolution, and the daily operations of the business, the tax implications need to be carefully considered. Self-employment tax is high and if you are making or think you might make more than a specific annual cut-off, you will be responsible for estimated quarterly taxes, unemployment tax, excise tax (depending on your goods or services).
Leigh Law Can Help
Give us a call at Leigh Law to help you figure out the options and what the likely realistic result is in your circumstances! We’d love to Roar to your Rescue!
Call For A Free Case Evaluation
Case evaluations are completely free; our fees are flat and affordable. Call Leigh Law today at (501) 227-ROAR or Email Us to set up a free consultation.