Should You Incorporate Your North Bay Business into an S-Corp?
Following the passage of the 2017 Tax Cuts and Jobs Act, viral messages circulated on social media recommending that all sole proprietors and small businesses should incorporate to maximize their deductions.
Of course, such sweeping generalizations are rarely correct. Tax codes are not one-size fits all. You might know a friend or business owner who has incorporated their company, but that doesn’t necessarily mean you should.
The Entrepreneur Spirit
Entrepreneurs are risk-takers; it takes courage to start a business, and that innovative spirit is important to getting your dream off the ground. But the flip side of risk-taking is impulsivity and leaping before you look.
A client once came to us to file his business taxes. His annual returns were generally about $2000, but when we looked over his paperwork, we realized he had established a corporation.
He didn’t have any of the necessary records, or a payroll system – he didn’t even know what 1099 was. A simple tax appointment suddenly became triage for his company.
Before you decide to incorporate, you should ask yourself, “Why?” What benefit are you seeking by incorporating your business? And will incorporating really help you achieve that goal?
For many, the answer is taxes. Business owners often seek to pay less of their profits to the IRS and assume incorporating will always cut costs. For others, becoming a corporation can make a small company seem larger.
What Happens When You Make The Wrong Entity Choice?
It is important to research business entities and speak with an expert about your options. Too often, Marin business owners come to ProActive Tax Solutions having established a corporation on their own through LegalZoom. They find themselves stuck in an expensive corporate infrastructure that they cannot sustain.
Does your vision of your company include raising capital? Or do you own a Marin medical practice? Your answer will impact the type of business entity that is right for you.
Business Entity Classifications
There are three main business entities that can be used in the United States:
- Limited Liability Company (LLC)
LLCs are nimble structures that protect business owners from liability. In a sole proprietorship, the owner of a company can use their personal bank accounts to conduct their business. An LLC requires the company to have its own bank accounts, or for the owner to designate that they are “doing business as (D.B.A.)” their company when using personal accounts.
As the owner of an LLC, you are shielded from lawsuits in case there is a problem with your company. If a customer or former employee attempts legal action against your LLC, it is unlikely that your personal assets will be impacted.
Many sole proprietors and/or independent contractors may believe it is always in their best interest to incorporate, but that is not always the case. In California, the associated fees can be expensive. LLCs must pay $800 a month to the state simply to exist, and a gross receipts tax is owed once sales exceed $250,000.
That’s sales – not profits. Your company could operate at a loss and you will still owe that money. Whether you are a single-member LLC or have many employees, those fees are the same.
C-corps pay corporate taxes on their earnings, unlike LLCs and S-corps, which pass-through earnings to individuals at their personal tax rates. Depending on the size of your business, this could save – or cost – a lot of money.
C-corps must meet a series of requirements each year to operate, including hosting annual shareholder meetings, establishing a board of directors, making state and federal filings, and keeping meticulous records.
Small companies could find that the cost of maintaining a C-corp obliterates their profits. It is essential to review your company’s finances before registering as a corporation.
S-corps are a classification given to companies where corporate income, losses, deductions, and credits are passed to shareholders for federal tax purposes. They are also known as “pass-through entities.”
Rather than paying most taxes at the entity level, the shareholders instead report the corporation’s income and losses on their personal tax returns and are then taxed based on their individual income rates.
S-corps, like C-corps, require thorough recordkeeping. To benefit from this structure, you will need to have been in business long enough to support payroll operations.
ProActive Tax Solutions has worked with sole-proprietorships, LLCs, and large companies seeking to incorporate. We can advise you on which business entity (if any) will be most beneficial for your situation.
A typical CPA may hand you a chart outlining the differences between these corporate structures but may not be able to advise you on which one you should choose.
At ProActive Tax Solutions, we work closely with our clients and take a “proactive” approach. We can examine the pros and cons of incorporating your business.
Let’s further examine the pros and cons of one business entity: The S-corp.
The Pros of Having An S-Corp In North Bay
The main reason many companies elect to become an S-corp is because it helps them avoid double taxation. Double taxation occurs when a corporation pays tax on its profits while shareholders also pay taxes on the dividends they receive from the corporation.
It can also happen when shareholders are employees at the corporation and are paid a salary. The shareholder-employees would have to pay taxes on both their salaries and their dividends.
In an S-Corp, shareholders pay taxes on the profits directly, so double taxation is avoided. Additionally, S-corp shareholders don’t have to pay self-employment tax on the profits they make from the business.
What Are the Cons Of Setting-Up An S-Corp?
S-Corp finances become more complicated when shareholders are also employees at the corporation. Every shareholder-employee must be paid “reasonable compensation” for their work, which is subject to regular Social Security and Medicare taxes.
Because of this, S-Corp status truly only benefits companies that make enough to pay that reasonable compensation, and still have leftover profits that would need to be taxed.
It’s also important to keep in mind that while S Corps pass some taxes through to their shareholders, they still are required to pay certain taxes at the entity level as well.
Additionally, S-corps are expensive to maintain. Annual fees can eat into the profits of small businesses, making them a less-than-ideal choice for a single-person company that wants to use corporate status to appear larger.
It also costs money to close an S-Corp, once established. People don’t often plan for the closing of their business, but it is wise to think about before transitioning to a new business entity. How will you close the corporation if your business fails?
It is quite difficult to get out of an S-Corp; you can’t just decide to close up shop. If the business doesn’t work out, you are legally stuck with your business partners and shareholders.
The “DIY” Spirit Doesn’t Always Save You Money
It is possible to set up a corporation online using sites like LegalZoom, but there are no checks and balances on these sites. They won’t ask any questions about your business – like how much you
make, or how many employees you have. Many entrepreneurs have tried to save money by foregoing an expert’s opinion, only to lose far more by making a rash financial decision.
ProActive Tax Solutions can give our expertise in bookkeeping, accounting, personal and business taxes. Before you incorporate, give us a call. We will help you determine if you are ready and can support the associated fees.
We will interview you and get the full picture of your business. It doesn’t matter if you’re going to manufacture, import, sell, or consult – we have clients of all kinds.
Work with a Local Tax Expert Near You
With ProActive Tax Solutions, you have peace of mind, knowing your taxes are overseen by an IRS-Enrolled Agent with 25 years of tax preparation experience: Georgia Rogers, E.A. Our tax return services start at $650, click here to see our pricing for 2020 tax preparation.
In addition, we also licensed to represent clients before the IRS and the State of California if you are selected for an audit.
Our office is located on Paradise Drive, just off the 101 at Tamalpais Dr. Call us now at (415) 924-6240 to set up a free, 30-minute consultation. You’ll quickly understand why we are the choice for residents in the North Bay Area.