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When Is it Advantageous to Form an S-Corp

If you’re starting your own business, you may be wondering how to set up and structure the business in a way that allows you to stay within the bounds of the law, but also limits the amount of taxes you are required to pay to the IRS. Those who operate their own professional practices (such as doctors, lawyers, dentists, accountants, engineers, etc.) or individual consultants should consider forming an S corporation. The Freeman Lovell team can help you with this endeavor.

Pros of Forming an S-Corp

The biggest advantage of forming an S corporation is that it can save you money on taxes. People who own their own businesses and are not in the employment of others must pay higher FICA taxes (Social Security plus Medicare). That’s because when an employee works for a company, the company pays half of the FICA taxes and the employee pays half. But when you are self-employed, you must pay both portions.

As you can imagine (or may already know well), this can be a sizeable sum. When you form an S Corporation, instead of paying FICA taxes on all the revenue you collect, you only pay them on your salary, which is a number you determine based on the going rate for that job in your particular market.

This move can save you many thousands of dollars. But it isn’t easy to do and there are many caveats, so it’s critical to enlist the help of a professional accountant when you make this decision.

Another tax benefit you can reap from forming an S corporation is that it can function as a pass-through entity. This means you don’t have to pay corporate income tax; instead, you pay taxes as if your revenues are personal income. This is only advantageous in certain situations, however.

Cons of Forming an S-Corp

One of the biggest cons of forming an S corporation is that if you make a mistake, you could end up owing the IRS tens or even hundreds of thousands of dollars.

That’s because operating an S corporation has strict and specific rules.

First, you may only have one class of financial stock. You cannot have preferred shares with different owners receiving varying distributions of profits and losses like you can with a partnership.

Second, your S corporation must be a small business — you cannot have more than 100 owners.

Third, only individuals and not businesses or groups are allowed to invest.

And lastly, no foreign investors are allowed.

This may seem uncomplicated at first glance, but it’s easier than you think to make a mistake. What if you accepted investment money from an individual whom you assumed was an American citizen but was, in fact, not?

A mistake like this can wipe out a year’s worth of income. That’s because if the IRS finds out, they automatically start taxing you as if you are a C corporation. This may not cost you that much, but if you have appreciating or depreciating assets (such as real estate), this switch can get pricey.

Separately, an S corporation structure is not helpful for businesses that need investors, because it’s so restrictive. Thus, entrepreneurs who aim to grow their businesses over time would not do well with an S corporation structure.

The Bottom Line on S-Corps

Based on what you’ve learned here, if you think forming an S corporation would be advantageous to you — whether you are just starting your business or you have been in business for years and want to make the switch — talk to the team at Freeman Lovell.

Forming an S corporation can provide significant tax advantages, but it can also backfire if you aren’t well-versed in all the IRS rules, regulations and technicalities. Moreover, we always recommend that you involve your business lawyer in the decision as well since their advice regarding restructuring your business is invaluable. CPAs and business lawyers each have an important contribution to make the decision to form an S corporation.

Freeman Lovell is dedicated to assisting entrepreneurs and small-business owners with all their tax-related issues, including forming an S corporation.

Call or text us at (385) 217-5611 or send us a message through our Contact Form .

28 Dec, 2023
In a couple of months, a new rule will take effect, requiring all registered legal entities to report their beneficial owners to the Financial Crimes Enforcement Network (FinCEN). We wanted to give you a heads up about the rule and give you as much information about what it means to you. What is the rule? The rule, which is called the Beneficial Ownership Information Reporting Requirements (BOI Rule), comes from the Corporate Transparency Act, which was passed by Congress in 2021. This law created the BOI Rule with FinCEN as part of the U.S. government’s efforts to make it harder for bad actors to hide or benefit from their ill-gotten gains through shell companies or other deceitful ownership structures. Under this new law, FinCEN will permit Federal, State, and local officials to obtain ownership information for authorized activities related to national security, law enforcement, and intelligence. When does the rule take effect? And when do I have to submit a report? The BOI Rule takes effect on January 1, 2024 . If your company existed before January 1, 2024, you must file its initial beneficial ownership information report by January 1, 2025. If your company is formed or registered after January 1, 2024, you must file its initial beneficial ownership information report within 30 days after receiving actual or public notice that its creation or registration is effective. If any beneficial ownership information changes, you will have 30 days from the day of the change to file an updated or corrected report with FinCEN. What do I need to include in the report? The BOI Rule requires that all entities report information about the company, each individual with substantial control over the entity, and each beneficial owner. What information is required to report about the entity? Full legal name of your company and any DBAs names; Complete current street address for your company's principal place of business (P.O. boxes will not be accepted); The jurisdiction of formation or registration; and Tax identification: IRS tax identification number (TIN) and employer identification number (EIN). What information is required to report about the controlling individuals and beneficial owners? The individual's legal name; Individual's date of birth; Individual's residential address; and A unique identifying number from an acceptable identification document (such as an unexpired driver's license, passport, identification document issued by a State or local government or Indian tribe.) and the name of the issuing state or jurisdiction. Who is considered to have substantial control of the entity? Examples of an individual that exercises substantial control over the entity are: An individual is a senior officer (President, CEO, CFO, COO, Manager, or other office who performs a similar function); An individual has the authority to appoint or remove certain officers or a majority of directors of the reporting company; An individual is an important decision-maker for the company; or An individual has any other form of substantial control over the company. Who is considered a beneficial owner? A beneficial owner is an individual that owns or controls at least 25% of the entity’s ownership interests. This includes individuals that indirectly own or control 25% of the ownership interest. For example, if Joe is a 50% owner of Parent LLC, which in turn owns 50% of Subsidiary Corp, then Joe beneficially owns 25% of Subsidiary Corp (50% of 50% = 25%). What type of entities will be required to file a report with FinCEN? All domestically formed entities and foreign registered entities in the USA are required to file a report. Types of entities include corporations, limited liability companies, limited partnerships, general partnerships, and any other entity registered with a state Secretary of State or Division of Corporations or other similar office. There are some types of companies that are exempt from the reporting rule, and in general they are companies that already have to report beneficial ownership to another federal agency. The 23 exemptions listed by FinCEN are: Securities reporting issuer, Governmental authority, Bank, Credit union, Depository institution holding company, Money services business, Broker or dealer in securities, Securities exchange or clearing agency, Securities exchange or clearing agency, Other Exchange Act registered entity, Investment company or investment adviser, Venture capital fund adviser, Insurance company, State-licensed insurance producer, Commodity Exchange Act registered entity, Accounting firm, Public utility, Financial market utility, Pooled investment vehicle, Tax-exempt entity, Entity assisting a tax-exempt entity, Large operating company, Subsidiary of certain exempt entities, and Inactive entity. Now what do I do to comply with the BOI Rule? While you are not able to submit the beneficial ownership information report until January 1, 2024, you should use this time to gather information about your company, owners, and other entities now, so you can timely file your report. We added a small BOI Rule cheat sheet for you to keep and reference. Also, you can read FinCEN’s FAQ page about the BOI Rule https://www.fincen.gov/boi-faqs . Can you help me with my company’s report? Yes! We are happy to help prepare and file your company’s BOI Rule report with FinCEN. We can begin to gather and prepare the information for your filing right away and be ready once the BOI Rule takes effect January 1, 2024. To get started, please reach out to us. We also know that some situations can be complicated, so please feel free to ask us any questions regarding compliance with the beneficial ownership interest reporting requirements for your company.
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