S Corp Benefits
Posted July 22, 2018
S Corp benefits can be huge, but how does it all work? In other words, what are the steps from nothing to a well-oiled machine? The life cycle of an S corporation is a common concern among small business owners. The objective of this web page is to address this concern directly but also to demonstrate that it truly is no biggie to own and operate an S corporation. Far too often we see business owners pass on the S Corp election simply out of fear of the unknown, which is unfortunate. Then again, we can’t save everybody.
So, here’s the soup to nuts… the description of a full course dinner, in which courses progress from soup to a dessert of nuts, according to old English. Also, just like your mother says, no dessert until you finish your meal. In other words, no jumping ahead!
Littered throughout our website are the benefits of having an S corporation. Primarily it is the reduction of self-employment taxes (namely Social Security and Medicare taxes). Other benefits such as company cars, solo 401k plans, improved flexibility of tax deductions, and several other things are available to you, as a small business owner, with or without the S corporation election. To reiterate, S Corp benefits should be singular since the primary (and some would argue the only) objective is the reduction of self-employment taxes (not just income taxes).
Before you get too far down this road, you need to answer some basic questions about being an S corporation. If you have already passed the test, so to speak, you can move along to Step 1 below.
S Corp Election Checklist
Before we get into the fees and how it works, and all that jazz, let’s go through a quick checklist to ensure that we are not going down the wrong road-
- Does your business earn over $30,000 net income after expenses? Say Yes.
- Are you located in New York City or Tennessee where S corporation tax rates are egregious and suck up all the federal tax savings? New Hampshire? Say No.
- Do you have other W-2 income that exceeds or comes close to exceeding the Social Security limits of $128,400 (2018)? Say No. If you say Yes, we need net business income to exceed $200,000 in #1 above so that the Medicare savings exceeds the “lost” Social Security tax paid by the S Corp.
- Is this a going concern? In other words, is the business going to continue to earn the same income or more each year? Say Yes.
- Do you have an LLC or some other entity in place that can be elected to be taxed as an S Corp? Say Yes. If you say No, we have options just not elegant ones such as shelf corporations.
- Do you have other partners besides a spouse? Aren’t we getting personal… we mean business partners, that is? Say No. If you say Yes, are you currently splitting income based on ownership percentages or some formula? If you say Formula, then we’ll need to explore a multi-entity arrangement.
- Does your entity own any appreciating assets such as real estate? So No. We don’t put appreciating assets into an S corporation. Holding companies own real estate and operating companies elect S Corp status. Chinese Wall.
Are you still here? Excellent news… read on! You can also complete a PDF version of the above questions, and send them to us for review-
Common S Corp candidates and current clients for the Watson CPA Group are consultants, engineers, financial advisors, physicians, chiropractors, doctors, surgeons, anesthesiologists, nurse anesthetists, insurance agents, attorneys, photographers (the profitable ones), online retailers, FBA retailers, real estate agents, good old fashioned widget makers, among several others. We also have several medical groups and financial advisor teams. Yes, even those deemed to be specified service trades or businesses still benefit with Section 199A coupled with an S Corp election!
Step 1. Create an Entity (the soup)
You need an underlying entity that can be taxed as an S corporation. As you might be aware, an S corporation does not exist in the literal sense. It is the result of a tax election on an existing entity. The most common underlying entities are limited liability companies (LLCs) and corporations including professional corporations (certain states require accountants, attorneys and physicians to be professional corporations).
The entity creation step can take anywhere from 30 minutes (Colorado, Wyoming, Florida to name a few) to 4 weeks (California, Pennsylvania, New York, Arizona). Shelf companies are available but more discussion is required and there some risks.
Step 2. Obtain an EIN
The IRS issues an employer identification number (EIN). If you have an EIN issued to you as a sole proprietor, then you will need a new one. The IRS has a decent webpage that answers the question “Do I need a new EIN?” Check it out if you already have an EIN from a previous life / entity.
We might be able to resurrect an old EIN that you obtained several years ago. Unlike social security numbers, EINs are not presently recycled. That might change as the rate of small business growth continues to boom.
You will need an EIN for three really big reasons- Form 2553 (S Corp Election), bank account openings and payroll account setup. We can always obtain the EIN concurrent with the Secretary of State filing for the entity creation; however, we caution against this since business names might change or be rejected. And… there is no benefit of having an EIN without Articles of Formation / Incorporation since the bank will want both (Articles + EIN = bank account).
Step 3. S Corp Election
Form 2553 is completed and sent to the IRS for processing. Current times are 8-10 weeks but we don’t sit on our hands… we continue tackling all the other steps.
Step 4. Bank Account Opening
Concurrent with Steps 3, 4 and 5, you need to open a business banking account. Some business owners will try to use another personal account as a compartmentalized bank account separate from their personal finances. This works right up to the point of needing a voided business check for payroll account (see Step 5). In the past, business banking was expensive with monthly fees, crummy balance thresholds and blah blah blah. Times have changed, and banks are needing to be much more competitive.
From a record keeping and compartmentalization perspective, a separate bank account is just good practice. All the money in is revenue or a loan. All the money out is either an expense, distribution, or loan payment. Personal is separated, and if necessary financial statements can be quickly rebuilt from your bank records.
Step 5. Payroll Account Setup
This is the most challenging step quite frankly, and it generates some confusion. A couple of questions that we get often… Do I really need payroll? Yes. But it’s just me… I don’t have any employees or anything. Do I still need payroll? That’s lovely, but Yes. Pretty clear, hopefully. The backstory is quite simple-
As an owner of an S corporation you wear two hats, a) investor and b) employee. As an investor, you receive dividends or distributions from your investment. As an employee, you receive paychecks which require quarterly and annual filings. The second element to the payroll requirement is the demand, the unruly and highly objectionable demand, of the tax code to force S corporations to pay a reasonable salary to its active shareholders. Here is a web page dedicated to reasonable shareholder salary-
Another question we get is… I live in Texas. We don’t have an income tax so I don’t need state payroll accounts. Wrong. Every state collects and administers unemployment compensation, and as such, collects unemployment taxes. Unemployment tax is unavoidable, and there are times where it is better to pay the federal unemployment versus the state unemployment taxes. There are other taxes as well such as state disability and local city taxes. We have a great article about this here-
If you have the Watson CPA Group process your payroll (and you should since payroll is easily broken by the smartest of people, even accountants), we need a voided business check for ADP setup. There are several ways to satisfy this-
- If you have written any checks, images of those canceled checks may be used.
- A letter from your bank on letterhead detailing the routing and account numbers may substitute (this is a common request, and the bank should have a form letter).
- Screenshot of online bank account showing the full (no masking) routing number, account number, legal business name and bank logo.
- Bank statement showing the same items in #3 above.
This hassle is to curb check fraud. Sorry. More bad news… some states are terrible and can take upwards to 4-6 weeks to process the paperwork for payroll account setup.
Step 6. Tax and Salary Projections
We need to project your business income, salary and cash needs so you have a tax neutral position for April. Quick list of things we need-
- Projected net business income after expenses for 2018 (do your best, and we’ll revisit throughout the year).
- Tax returns from 2017 (if we did not prepare them).
- Most recent paystubs from all household income sources.
You can submit tax returns, paystubs and other sensitive information to your client portal (Portal button on top of page, upper right). Use the following link to submit your business data via a fillable PDF-
Step 7. Recurring Activities (the nuts)
After your entity is set up, the S Corp election is made and payroll accounts are setup, then your S Corp benefits turn into a barrage of lather rinse repeats. Generally speaking Q1 and Q2 payroll are decided early in January or even late December. These are on autopilot. Q1 and Q2 are often minimum payrolls for seasonal professions such as real estate agents or landscapers.
Q3 is a mid-course correction or true-up. We obtain updated business income numbers to project salary recommendations and tax liabilities for the entire year.
Q4 is where the runway ends, and all the cans that were kicked down the road (at your request) start to pile up. Q4 is critical. It is the last payroll event where we need to ensure that your salary is reasonable, and that health insurance, HSA and 401k information is accurate (since it is reported on your W-2).
Don’t forget tax returns! S corporation tax preparation and tax returns are due March 15. While S Corps are a pass thru entity, and as such passes its federal income tax liability to the shareholders, some states such as California, New Jersey, Illinois, among several others, have a state tax that is due.
Scattered throughout the year is unlimited consultation, tax planning and periodic business reviews (PBR). Here is our agenda-
There’s your soup to nuts, and we hope that this clears up the life cycle of the S Corp. As you can tell, it is a two step process- the launch and the administration.