In my six years of helping business owners incorporate, I can’t tell you how many conversations I have had with clients that say they need to form S-Corps because their accountants’ told them to. That’s fine from a small business stand-point, avoiding entity level taxation so that profits and losses flow through to the owners is how you’d want to be taxed anyway.  But that’s just it.  IT’S A TAX STATUS!  Many accountants are familiar only with the taxation of a corporate entity, and that’s the way it should be……..that’s what you pay them for.  But when it comes to choosing the type of company that suits your organization’s structure (one person), a corporation is not always the best fit.  You do have options.

After leaving the accountant’s office now you think you need to incorporate, so you start doing some research on the internet for “S-Corp”.   What you’ll find is lots of sites that explain what the S-Corp is but none offer to really set one up for you.  Why is that? BECAUSE IT’S A TAX STATUS!

Now what?  Maybe you try searching “corporation” or “incorporate”.  Well, look out because now you’ve opened the flood gates; oodles of companies willing to help you incorporate overflow into the computer’s tropical fish background.  You start checking out a couple of websites, and gather information about packages and pricing, but still no S-Corp.  Don’t make me say it again…….

Eventually you make a phone call to one of the online incorporators.  The service representative asks how they may help you, and you say, “I need to form an S-Corp”.  At this point you’re already well on your way to forming a corporation.  Next thing you know you’re talking shares of stock, board of directors, officers, meetings, minutes, blah, blah, blah.  Sounds like a lot of work just to become an S-Corp so that your accountant’s job is easier, especially if you were a sole proprietor to begin with.  Rather than forming a corporation, consider forming an LLC instead. That’s right I said LLC.

With the LLC, you all but eliminate the formalities of the corporation while limiting your liability for the debts and obligations of your business.  And best of all, the IRS treats the LLC as a flow through entity by default.  What does that mean?  It means that if things don’t work out with the accountant and you don’t end up electing S-Corp status, you can still file your taxes like when you were a sole proprietor.  This will work for partnerships too.  Regardless of whether you choose a corporation or an LLC, once the entity is formed you’ll still need to file with the IRS to obtain that S-Corp status.  If you go LLC you will only need to file one additional form (IRS Form 8832: Entity Classification Election) to be considered for S-Corp treatment.  So what’s one more form?

General qualifications for S-Corp status include:

• The entity is a domestic corporation.  (Other entities, including LLCs, may become eligible by filing form 8832.)
• The entity has no more than 100 shareholders
• The entity’s only shareholders are U.S. individuals or estates
• The entity has no nonresident alien shareholders
• The entity offers only one class of stock
• Each shareholder consents to the election

If your entity meets or will meet the qualifications above, HBS can help your corporation complete the election so that it can receive the benefits of pass-through tax treatment. The service includes completion of IRS Form 2553: election by a Small Business Corporation, a pre-addressed envelope with IRS regional office address, and instructions for filing.  All you and the other shareholders need to do is sign the form and mail it, with absolutely no guess work. Harvard makes it that simple.

If you’re forming a brand new Delaware corporation, simply go to www.delawareinc.com/order and you can add the Federal Tax ID and the S-Corp Election services right online while completing your order. If your company has already been formed and would like to become the S-Corp election, call 800-345-2677 and have Harvard Business Services prepare your paper work today!

Though there are tax benefits to being a sole proprietor (no employees = no payroll tax–huzzah!), you are personally liable if a legal situation arises. This is especially important for those providing services like construction and financial consulting.

“If you are dealing with individuals’ money that is typically invested in the stock market, this tends to be a very sensitive [and potentially litigious] issue,” says Robert Fuest, principal of LandorFuest Capital Management. “You must understand all of your risks.”

Those risks go beyond just upsetting a client. For instance, a default on a debt or other payment can result in a creditor legally coming after your personal property and assets or other possessions.

Fuest advises new business owners to look at their entire financial situation and take into account any plans to grow and include partners and employees. “The LLC offers more flexibility when it comes to operating and more personal protection,” says Fuest.

Once your sole proprietorship is up and running, Fischer recommends treating your business like a business, something that those who freelance from a home office would do well to remember. “Be professional at all times and make time for things like marketing and networking.”

This includes everything from having professional-looking materials (business cards, letterhead, invoices, etc.), to answering the phone properly and dressing appropriately. Deshayes says this can go a long way toward impressing clients and making them comfortable giving you work.

When purchasing these materials, Deshayes says it’s important to keep personal money and business funds separate. “Keep your books clean and avoid comingling funds, which could open you up to legal liability.”

Though there is no mandatory income threshold, Estill uses a guideline of around $50,000 per year gross as a starting point to consider converting a sole proprietorship to an S corporation (assuming they are not at risk for liabilities–then, forming an LLC would make more sense).

Estill says the primary tax benefit of an S corporation is that the owner controls the payment of employment taxes (via a declaration of salaries or wages). In a sole proprietorship, all net profits are taxed at the self-employment rate, which is currently 15.3 percent on the first $106,800 of net business income.

That rate remains the same for either structure, but the business owner can save some money with the S corporation. They may draw a salary (let’s say half of what they’d declare as net income on a sole proprietorship) and pay the 15.3 percent on that. “The rest of the income flows to your personal tax return on a Schedule K-1, which ends up being subject only to income taxes,” observes Deshayes.

There are costs associated with setting up an S corporation, including filing fees and corporate taxes, but Estill says, “The S corporation can be set up in any of the 50 states with only one shareholder, so it is an ideal business entity for a single-person venture.”

Fuest advises looking before you leap, no matter what the structure. “The laws always change, and depending on the size of the business, you could be at an advantage one year and a disadvantage the next. It really comes down to your personal plans for growth.”

Read the full article HERE.

Mitch’s Question:

I currently have a C-corp with HBS.  There are only 1,000 shares of stock and I own them all.  No employees and my wife is the corp. secretary.  Can I convert my C-corp into an LLC? Can Harvard do it?  Is it easy to do? Cost? Do I need to change the name?  I assume I need to revise the Fed. EIN.

Thanks,
Mitch
Maryland

Answer: Mitch, if you have a Delaware C-corp we can easily convert it to an LLC for you, officially, with the State of Delaware and the IRS. The filing is called a “conversion”. Our service includes all document preparation, filing, Delaware filing fees, a new LLC minute book with seal and membership certificates and filing the IRS notice. Even includes shipping! The “ending” of your company name will change to LLC. Call for a quote.

Tyrone’s Question:

I formed an LLC with HBS and now my accountant wants me to be an S-corp. Can I do this? Can Harvard do this for me?
Let me know.

Tyrone
Colorado

Answer: Tyrone, the federal government does not recognize the LLC as an entity for tax purposes; therefore LLCs have the opportunity to elect their desired tax classification. By default, a single member LLC is classified as a “disregarded entity” or the LLC is ignored for the purpose of filing a federal tax return.  Multiple member LLCs will be considered partnerships for filing purposes by default. Bear in mind, these designations are for federal tax purpose and do not change the fact the business is a Limited Liability Company. An LLC not accepting its default status must file Form 8832 to elect the entity’s classification. This form allows an LLC to be recognized as a corporation for the purposes of filing taxes. Once an LLC files form 8832 with the IRS and elects to be recognized as a corporation, it becomes eligible to file Form 2553 and elect sub-chapter S tax status. Ideally, an LLC seeking S-corp status will file Form 8832 and Form 2553 with the IRS, simultaneously.

If you have questions about CHANGING your company from one entity type to another, or electing different tax status, give us a call or drop us an email. We can’t advise you on what to do, but we can help you change from one form of entity to another, if you want to.

In the USA, we have wrestled with the “dividend” tax in many ways, but the creation of the IRS tax code known as “Subchapter S” is probably the best-known and most effective way to avoid double taxation. Basically, it says a company organized as a S-Corporation does NOT PAY TAX at the entity level. Instead, the company passes its dividends through to its shareholder and THEY pay the tax on their portion of ownership.

Now, pass through tax treatment can also be achieved through the LLC but major corporations, with thousands of shareholders cannot avoid double taxation since there is 100-person limit on the number of shareholders an “S Corp” can have.

This blog category will help you understand all the benefits of an S-Corporation as time goes on. We invite you to join the conversation by leaving a question or comment.