First off, if you missed our Blog Post or Podcast Episode last week on “What Is An S Corp?” you will definitely want to check that out as it leads into this one.
Also, I just want to let you know that we did an entire series on S Corporations on both our Blog and Small Business Tax Savings Podcast, so if you want to dig deeper from what we discuss today, check that out.
We also have a very in depth deep dive into S Corporations as a Module in our Tax Minimization Program. If you are a member you will want to go through that entire module, if you are not a member now is a great time to join!
Alright, so with all that being said, lets dive into days topic, when does it makes sense (or doesn’t make sense) to be an S Corp!
What Are The S Corp Requirements?
Before we dig into that, lets first discuss the requirements to even elect S Corp status.
- Must be organized initially as an LLC or Corporation. Remember this is simply a tax election so you must first have a company open.
- If you are currently operating as a Sole Proprietor you will need to open an LLC or Corporation and then elect S Corp status.
- Shareholders may be individuals, certain trusts, or estates. May NOT be a: partnership, corporation, or non-resident alien.
- Cannot have more than 100 shareholders.
- Can only have one class of stock.
- All shareholders must consent to the election.
When Should I NOT Be An S Corporation?
Often times accountants are very quick to jump on the S Corp band wagon but there are some things we should discuss on when it really may not make sense for you to be one.
- Your Business is Small
- As we talked about last week, S Corporations have some disadvantages, specifically a separate business tax return and W2 payroll required. If you are a small business making say $20,000 a year, these added compliance costs will eat into all of your tax savings you may get with an S Corp.
- You Have Foreign Owners
- As we talked about above, a non-resident alien cannot be an owner of an S Corp so if you have foreign investors you are not allowed to elect the S Corp status.
- Unfavorable State or Local Laws
- There are a few (not many) states and localities in the US that may have an unfavorable treatment to S Corp which could eat at some of your savings. You would need more in-depth analysis to see if it makes sense.
- Examples are New York City and Tennessee. If you live in one of these, you will want to talk to a tax professional to go through your specific scenario deeper.
- You Have Another High Paying W2 Job
- The biggest reason to elect S Corp is for self employment tax savings. If you have a high paying W2 job you may be maxing out social security taxes ($147k in 2022) already and thus your savings would only be roughly 3%. Again this could minimize your savings under an S Corp unless your S Corp is earning $200k+.
- Expecting Business to Decrease or Close Soon
- If you are expecting your business profits in the future to be low or you plan to close your business in the near future, again an S Corp may not make sense due to the added compliance costs.
- Planning to Go Public Soon or Have Lots of Investors
- With an S Corp you are limited to only one class of stock and 100 shareholders so if you plan to go public or bring on different type of investors an S Corp setup likely would not be the greatest fit.
As always with a decision like this you should be running it past your tax advisor to ensure that this decision is the right one.
When Should I Be An S Corporation?
Alright, now lets talk about those of you that should elect S Corp status. Again, these are all general guidance and your specific scenario should be discussed with a tax advisor.
- Business Profit of $50,000 or More
- As we know with the added compliance costs (separate business tax return and payroll) of an S Corp, you want to make sure you have enough profit to outweigh those added costs. $50,000 is a good benchmark for that!
- Expect to Maintain Profit of $50,000 or More
- Having an on-going expectation of that income level is also key. If you are making $50,000 this year but expect all future years to be $15,000 then it may not make sense to get the benefits for just one year when it may hurt you down the road.
- Solo Owner / A Partner or Two
- If you are a solo business owner or just have a partner or two, an S Corporation will likely play in well with that. We are going to be talking next week about different entity structure setups with multiple businesses or partners.
- Key thing here is that typically we will go a different route if there are a lot of owners or outside investors.
- No Other High Paying W2 Job
- Most people we put in an S Corp, it is their main source of income. They do not have other W2 jobs that they earn a high salary in. Their business is their high income.
Like I said in the beginning I highly recommend you check out our Blog Post or Podcast Episode last week on “What Is An S Corp?” or our series Everything You Need To Know About S Corporations if you want to learn more about S Corps.
- S Corporation Strategy
- Payroll Tax Savings Calculator – Run scenarios of your specific situation to see what savings you would have.
- S Corporation Disadvantages
- Deciding If An S Corp Is Right For You
- Exact Steps on How To Elect S Corp Status
- How to Determine a Reasonable Salary
- Reasonable Salary Worksheet
- How to Setup Payroll for An S Corp
- Steps You Need to Take After Electing S Corp Status
- and so much more…