The majority of S Corporation businesses did not start out as S Corporation businesses.
According to the Small Business Administration, most businesses are started as sole proprietorships. 73.2% of all small businesses, in fact, operate under that legal structure.
Some businesses, though, eventually outgrow the sole proprietorship structure. That’s when business owners start to think about incorporation, though most want to be sure that they are timing this big decision perfectly.
Here are some of the signs business owners use to know it’s time to make the transition to an S Corporation.
Better Protection for Your Personal Assets
While a number of different business entities and structures can protect personal assets, S Corporations are particularly well-suited for this purpose.
Unless business owners provide express (usually written) personal guarantees on behalf of the business, personal assets of business owners can’t be used to cover any business debts that may be generated by the S Corporation.
That’s an extra layer of protection sole proprietorships cannot provide.
Draw a Salary
Part of forming an S Corporation requires business owners to compensate themselves with a “reasonable compensation”.
This is written down in the S Corporation rules themselves, a requirement for this form of incorporation to happen in the first place. The fact that this salary can also be used as a tax deductible expense for the business is an added bonus
Create a Flexible Ownership Structure
Business ownership structures change over time, but only when the original structure is flexible enough to accommodate these kinds of changes without causing huge tax bills at the same time.
Business owners interested in bringing on minority (or majority) investors love the flexibility and freedom S Corporations offer.
Compare the flexibility of an S Corporation to a standard LLC or partnership, for example.
Transferring 50% or more of an LLC or partnership and the business is legally considered “terminated” just because of those business structures. S Corporations aren’t subject to those rules, and also don’t have to deal with complicated accounting procedures when new investors or new owners get involved.
Simplify Your Accounting Work
Traditional corporations are required to use what’s known as the “accrual method” of accounting.
S Corporations, however, only have to use that more complex form of accounting if they carry inventory.
When S Corporations do not have inventory (businesses in the service industries, for example) they can use simpler, less time-consuming accounting methods to track their finances.
Avoid Double Taxation Events
Incorporation generally provides extra layers of asset protection at the cost of higher taxes.
C Corporations, for example, are required to pay taxes on all their profits. Shareholders (including business owners of those corporations) then must pay taxes on any distributions of those profits or dividends that they receive.
That’s getting taxed twice on the same money!
S Corporations, though, enjoy a specific status that guarantees all dividends and distributions are only taxed a single time. Profits are better protected with the S Corp structure.
Get Professional Help from Robert Hall & Associates
All decisions to change the structure of a business must be very carefully considered.
This is not a decision to be taken lightly.
Business owners thinking about making the transformation into an S Corporation will want to (at the very least) seek the advice of professionals like Robert Hall & Associates.
Knowledgeable, experienced, and well-versed in every aspect of SCorporations, these professionals aren’t just able to provide great advice – they’re also able to navigate owners step-by-step through the S Corp incorporation process, too.
For more information about an S Corp, the pros and cons of this decision, and how to best move forward, reach out to Robert Hall & Associates today.
References
https://bench.co/blog/tax-tips/sole-prop-scorp-transition/
