Should we consider transitioning to an S Corp?
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So Karla registered her business as an LLC, and we're taking ownership of the company she's worked for on July 1st. She went with an LLC because it seemed to be the quickest and easiest way to get set up and running, and she was in a bit of a time crunch, but the more I'm researching it, I am wondering if it would be best transition to an S Corp. It looks like there would be significant savings in the self-employed tax if she just paid herself wages instead of taking owner's disbursements. On the other hand, the S Corp rules can be a little more limiting if she needs to make adjustments. For instance, all of the service providers except her will still be 1099 NEC contractors, but that may have to change over time depending on some of the pushes by the labor department to squash the gig economy.
She's not planning on taking on any partners or selling partial ownership to anybody else. The only other thing that we may do is start running a small real estate sidebar under the corporation in 3-4 years.
Does anybody have any experience with these things and any suggestions?
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S-Corp means having to run payrolls and file separate tax returns just for the business (as opposed to just a “Schedule C” along with your 1040). Running payroll costs money, filing additional business returns costs money, depending on the state, you may have to file additional paperwork and/or taxes just for being an S-Corp. Yes you may be able to save some money from self-employment taxes but only if your profit materially exceeds the fair wages of what you’d pay someone else to do the job. If I have to guess, I’d draw the line at $100k/year — if as “sole proprietor” your profit is above $100k/year (and you expect to maintain at least that level of profitability for a few years), then maybe it’s worthwhile to convert to S-Corp.
While the federal “self-employment taxes” are primarily Medicare and Social Security and are limited to the “wages” you pay yourself, state/local “self-employment tax” can extend also to profit distributions, not just wages. And this can get tricky as the payroll service you use may not know how to handle all state/local self-employment taxes correctly when you call it “distribution” rather than “wages.”
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Seems Karla has been essentially managing the business herself. Therefore, her wages over the last couple years are a reasonable determinant of what constitutes the "fair wages" that she'd have to pay herself, before taking the rest as distributions/or whatever. You can do that math on if the anticipated profit from the business makes it worth the paperwork costs and headaches of filling as an S-Corp make it worthwhile.
Personally, I'm still just a sole proprietor. (not even an LLC) At first, it was because I didn't have any assets to protect...After looking into it further though, LLC protections don't hold up to protect personal assets in the type of protection I feel would be most likely to be beneficial to me. (if I had multiple business though...that could change)
With respect to the service providers... I would very much encourage you to err on the side of making them w2 employees. Go ahead and look up IRS rules on employees vs 1099...I think you'd agree. Forget about how Uber and Door dash can call their people "independent contractors" Compared to other situations I've seen them rule on, that's complete bullshit, they just happen to be big enough to have some influence.
It really is quite easy anyway. I use Squares Payroll app. It's like $50/month, plus $5/per employee. Super easy to use, you can usually get workers comp insurance through it (and pay weekly) it generates all the important year end reports, etc. I run payroll for my employees in less than 2 minutes. I also use it for paying the couple subs I use. (an occasional tuner, and a person or two to help when there's work 'overflow')
It's just very important that you classify people correctly...If there was ever an injury, or if a relationship ends poorly--the company can be found liable, and you may become responsible for paying for an injury out of pocket, and/or having to pay an employees back social security and Medicare witholdings. The later just happened to a friend of mine, costing them thousands.
Maybe use the occasion of new ownership as the impetus for the change.
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S-Corp means having to run payrolls and file separate tax returns just for the business (as opposed to just a “Schedule C” along with your 1040). Running payroll costs money, filing additional business returns costs money, depending on the state, you may have to file additional paperwork and/or taxes just for being an S-Corp. Yes you may be able to save some money from self-employment taxes but only if your profit materially exceeds the fair wages of what you’d pay someone else to do the job. If I have to guess, I’d draw the line at $100k/year — if as “sole proprietor” your profit is above $100k/year (and you expect to maintain at least that level of profitability for a few years), then maybe it’s worthwhile to convert to S-Corp.
While the federal “self-employment taxes” are primarily Medicare and Social Security and are limited to the “wages” you pay yourself, state/local “self-employment tax” can extend also to profit distributions, not just wages. And this can get tricky as the payroll service you use may not know how to handle all state/local self-employment taxes correctly when you call it “distribution” rather than “wages.”
@Axtremus said in Should we consider transitioning to an S Corp?:
S-Corp means having to run payrolls and file separate tax returns just for the business (as opposed to just a “Schedule C” along with your 1040). Running payroll costs money, filing additional business returns costs money, depending on the state, you may have to file additional paperwork and/or taxes just for being an S-Corp. Yes you may be able to save some money from self-employment taxes but only if your profit materially exceeds the fair wages of what you’d pay someone else to do the job. If I have to guess, I’d draw the line at $100k/year — if as “sole proprietor” your profit is above $100k/year (and you expect to maintain at least that level of profitability for a few years), then maybe it’s worthwhile to convert to S-Corp.
While the federal “self-employment taxes” are primarily Medicare and Social Security and are limited to the “wages” you pay yourself, state/local “self-employment tax” can extend also to profit distributions, not just wages. And this can get tricky as the payroll service you use may not know how to handle all state/local self-employment taxes correctly when you call it “distribution” rather than “wages.”
Thanks. In this case, we do have to run payroll anyway, and already have a firm set up to do so, so that doesn’t really add any new costs or complications to the business, though we should verify that they are prepared to handle both owner distribution and wages appropriately. The prior owner was an LLC that took distributions but also had Karla as a W2 (she handled the administrative details for the company, submitted payroll, billing, scheduling, etc…in addition to being a service provider). Karla will add on a W-2 admin assistant as well, but for now the rest will be 1099…
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My dad did that with his business. He never took a salary but a once a year dividend. Saved a lot on taxes and especially on Ss/Medicare. I’m not sure how the current tax law addresses that, but you need the advice of an accountant or tax attorney. There’s a lot of extra work for any kind of corporation as opposed to an LLC. To reap the protections you have to be very careful not to pierce the “corporate veil”.
“I am fond of pigs. Dogs look up to us. Cats look down on us. Pigs treat us as equals.” ~Winston S. Churchill
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My dad did that with his business. He never took a salary but a once a year dividend. Saved a lot on taxes and especially on Ss/Medicare. I’m not sure how the current tax law addresses that, but you need the advice of an accountant or tax attorney. There’s a lot of extra work for any kind of corporation as opposed to an LLC. To reap the protections you have to be very careful not to pierce the “corporate veil”.
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I got out of that mess a few years ago. Dissolved my S Corp and work mostly for W2 income now. I still do some side hustle work which is 1099 based.
@mark said in Should we consider transitioning to an S Corp?:
I got out of that mess a few years ago. Dissolved my S Corp and work mostly for W2 income now. I still do some side hustle work which is 1099 based.
I I went that way too. My LLC still technically exists but it wasn’t worth bothering with. With W2 I could collect unemployment between gigs. As I got older I got pickier about what Work I’d take. And don’t get me started on the Covid bonanza.
