In an earlier post I had mentioned my main reason for becoming an S-Corp. If you did not read that article please click here . As a refresher, there is a tax advantage to becoming an S-Corp versus a sole proprietor or a C-Corp (however, there are some good advantages to becoming a C-Corp as well).
Unlike an LLC or C-Corporation the S-Corp can only have one type of stock. Let’s say you decide to acquire a shareholder, however, you are the one that has taken on the liability of many of the bills and purchasing of assets. In a case like this you would need to be careful with an S-Corp, especially if you are trying to create a complex relationship with the other shareholder(s).
Let’s say we have an LLC and we have 3 members. In an LLC we use the word “members” instead of shareholders and I will show you why. Johnny has $250,000 dollars to invest in his Sausage and Peppers food truck. (You can tell I’m Italian right :)). Johnny however, wants to motivate some hot dog guys from town so he calls Doug and Phil. Now, Doug and Phil know a thing or two about relish and sauerkraut…… heck, they were both born in Poland and have outstanding recipes.
Johnny brings these two valuable people into to the business. To give an incentive, Johnny tells them they can become members of the LLC. Johnny…. in a roundabout way can create any type of arrangement he wants with his business partners by handing over a share of his business. However, if Johnny were to make them shareholders in his S-Corporation, there isn’t a good and easy way to make them not part owners of the company.
If you want to bring on a business partner in an S-Corporation, your choice of an individual should be rock solid. You also should have a clear understanding that they are a shareholder(owner) of the company and are entitled to a percentage as owner of the company. It’s not easy to go into business with anybody. It’s your business marriage. Therefore, be even more mindful when doing so under a corporation especially and S-Corp.
Your average person can spend weeks and even months researching, investigating and analyzing the benefits of incorporating. It’s almost like someone decided to create a perplexing process of getting information with regards to entity choices. So, what are your choices? You have the S-Corp, C-Corp, Sole Proprietorship, LLC and the Partnership. Today we are going to focus on the S-Corp. The other day I was on the phone with one of my favorite clients. Let’s call him Sal. I really like Sal. He just turned 30 and is a very hard worker. I emphasize to him that he is a rare individual. I say Sal is special because prior to 30 he has been in business for the past 5 years and that alone is a feat in itself. Being in business and growing before 30 is not as common as we might think.
Sal calls me up and tells me that he really needs time to talk with me regarding: “Should he go forward with moving his accounting over to the S-Corporation?” I knew I was in for a treat because Sal is smart. He does his homework. Well, 2 hours later and a lot of back and forth we concluded that the S-Corp entity choice was right for him.
I was challenged that day and I decided to write this article. The next time a client calls me with regards to an S-Corp, I will lead him to my article. Here are the laymens terms on this topic.
As far as I can see, the absolute best reason to become an S-Corporation is that: An individual can waive an amount near 50% of his net profit that is subject to Social Security and Medicare tax (FICA). Now..listen carefully, this is not etched in stone. The percentage might be higher and might be lower depending on your role within the company. Let’s lay out some numbers.
If Sal makes $100,000 profit as a sole proprietor every single dime of that money is taxed at his income tax rate as well as the FICA tax.
If Sal was an S-Corp or taxed as an S-Corp (which an LLC can do, we can talk about that another day) he would have been able, depending on his role in the business to take $50,000 away from being taxed the FICA. The full amount is subject to federal income tax however, he does not pay payroll tax on the other 50%.
I caution small business owners about incorporating until they at least have 3 years in business especially if it is a low liability business. I have met too many people who started corporations prior to really having all that much business experience. The fees associated with incorparation, tax filing and here in California the “Franchise Fee” (this has nothing to do with a franchise) is way too much when you’re first starting out. The moral of the story is
Be Like Sal.