As a small business owner, you probably hear suggestions for your business in passing all the time - and the sources aren’t always the most reliable. These days, it might seem like everyone has an opinion on whether or not a small business should become an S-Corp. Regardless, once a hot topic is thrown into your brain, you start to ask yourself if it’s something you need to look into.
After all, S-Corps are the most common type of corporate business entity, but they aren’t the only one. In fact, there are three types of business entities: sole proprietorships, partnerships, and corporations.
Small business owners like you dig right into the different business entity options. Here at CSI, S-Corps make up a very large portion of our client base. We mostly work with clients who have revenue in the $350,000-$5 million revenue range, which is a sweet spot for S-Corps.
In this article, we’ll cover:
- What an S-Corp is
- The advantages and disadvantages of being an S-Corp
- How we have this conversation with our clients
What Is An S-Corp?
A simple way to think about an S-Corp is to remember “SMALL-Corp.” In order to be an S-Corp, you need to have less than 100 shareholders, all shareholders must be U.S. citizens, and you cannot be publicly traded on the stock exchange.
Essentially, an S-Corp is the opposite of a sole proprietorship in that the business’s taxes are separate from your personal taxes. Read more about sole proprietorship taxes here.
There are some opportunities that are unique to S-Corps. Here are some of the pros that make an S-Corp entity type sound preferable:
- If you had a loss for the year and have an additional job, you may be able to offset your losses against your other job’s W2.
- If you’re comparing corporations, an S-Corp is taxed at the individual’s tax rate, which is typically lower than the tax rate for C-Corps.
- S-Corps are also only taxed once on the individual’s tax return, whereas C-Corps are double-taxed.
Some limitations of S-Corps, especially compared to the benefits of other entity types, include:
- Not being able to accept foreign investors, limiting opportunities
- Not being able to be owned by another business, not allowing for affiliates or subsidiaries, except in special circumstances
- Not being able to have more than 100 shareholders, meaning you cannot do funding rounds
- Having a “corporate veil” as a more rigid corporate structure, not allowing you to use your personal accounts to pay for business expenses
How We Address S-Corp Discussions
When a client asks us about S-Corps, they are usually wondering what they are, if they should be one, and why or why not. However, it’s not all that common that a client asks us if they should become an S-Corporation; it’s much more common for us to notice opportunities for business entity type changes and to suggest them.
In your first strategy meeting as a new client, we review your revenue, ownership structure, financial outlook, and what your plan is for your business — or your exit strategy. These help us decide if your current entity type is the best one for your business. For example, it may not be advantageous tax-wise to become an S-Corp if your revenues are low or if you have not made a profit in years.
We can always help an LLC become an S-Corp, but guiding you to an attorney is part of that process. An attorney can help you register your business if it is new, as well as help you get an operating agreement that dictates to your shareholders and officers how to operate the business. If you currently have an operating agreement, you may need permission from everyone to change your business entity type.
Want to Discuss Your Ideal Business Entity Type?
With so many sole proprietorships, partnerships, and corporations to choose from, things can get confusing. Now that you’ve seen our breakdown of what an S-Corp is, its pros and cons, and how we discuss this with our clients, you have a better understanding of whether or not this common corporation entity type is best for you.
If you’re still wondering about S-Corps or another business entity type, CSI is ready to help — addressing it right in our initial strategy meeting. We’re well-versed in S-Corps since they make up a large portion of our client base, but we also know the ins and outs of other business entities after over 50 years of working with small businesses.
Let’s have a conversation about your concerns with choosing an entity type when we connect in a free consultation.
Otherwise, you can continue to read about other types of advice that your CPA can give you.