I always say that if you own a small business that’s a C-Corp, you’re not really benefiting from your entity type. Why is that? C-Corps are best for much larger businesses.
So, how do you change business entities? While choosing the right one can be very complicated, the actual conversion process is surprisingly simple! Let’s dive into the conversion process for S-Corps.
(Note: This does not mean that S-Corps are a “one size fits all” solution for small businesses. Please consult your tax professional before making a change like this.)
At CSI Accounting & Payroll, we’ve provided monthly accounting services to small businesses for nearly 60 years. We’ve helped thousands of clients analyze their business entity (and even switch entities if it’s beneficial), answering questions like:
Businesses must fit certain criteria to become and remain C-Corps and S-Corps. If you don’t fit those criteria, you need to make a change.
Otherwise, your business may even be older than the existence of S-Corps, and that’s the only reason you were ever a C-Corp to begin with. Or maybe you bought your business as a C-Corp and just didn’t change the entity.
But what if these are not the reasons you want to switch?
You may just want to change to take advantage of different benefits. Let’s talk about the two main ones: avoiding double taxation and deducting losses immediately.
This is a great benefit for when you’re profitable.
C-Corps pay tax at both the entity level and shareholder level, but S-Corps only pay at the shareholder level. You could save quite a bit on taxes as an S-Corp!
The only way to avoid this is to distribute all profits as payroll bonuses, but we don’t recommend it.
What if, instead of being profitable, you face losses? Luckily, corporate losses can be used to reduce your taxable income.
C-Corp losses carry forward to offset future profits, whereas S-Corp losses can be deducted immediately on shareholder tax returns to reduce personal tax liability right away.
These benefits are part of why 70 percent of our clients are S-Corps!
If you’re considering switching to an S-Corp before you’ve talked to your tax professional, then you’re ahead of the game – but not in a good way.
While the conversion process is simple, you may not truly know if switching to an S-Corp is the right option for your business.
There may be significant tax consequences, and an S-Corp election can’t be easily reversed. That means some C-Corp tax rules may still apply for 5-10 years after you make the change, and you can’t just switch back and forth often.
If your C-Corp owns assets that have appreciated in value, switching to an S-Corp could mean you really shouldn’t sell them for at least five years – otherwise, you could still face C-Corp taxes on the gain.
If your C-Corp has a lot of unused losses and switches to an S-Corp too soon, you won’t be able to use those past C-Corp losses to offset future profits. Instead, to maximize your tax benefit, you could continue being a C-Corp until you use up those losses.
An accountant can warn you of potential consequences like these, allowing you to adjust your timeline or even change your mind completely. Just make sure they know about your tax situation and any major financial decisions you plan to make in the next few years.
After you’ve received a tax professional’s opinion that converting from a C-Corp to an S-Corp is right for you – and that it’s the right time to do so – you can start the process!
It’s one simple step. Just file a Form 2253, and have all owners sign it. It’s not a tax form, and anybody can file it.
However, if you’re struggling to fill out the form or submit it, your accountant may be willing to help. At CSI Accounting & Payroll, our staff typically handles this for our clients.
Now that you know why a C-Corp would want to change to an S-Corp, why it’s critical to talk to a tax expert first, and how to do the conversion process, are you ready to check out monthly accounting services?
If so, please consider CSI Accounting & Payroll! We make analyzing your entity type a crucial part of tax season every year. To see if we can be a good fit for your business, click the button below for a free consultation:
Not ready to talk? That’s okay! First, learn more about what it’s like to work with us by clicking the image below: