Andrea Lyles, EA
What your CPA didn't tell you about becoming an S Corp
I'm going to just go ahead and get the disclaimer out of the way. I'm not a CPA and I'm not an attorney, so please consult with the appropriate credentialed individuals when making legal decisions. I am, however, a bookkeeping professional who cares and therefore feels the need to write this article.
Now that that's out of the way, what I have unfortunately found is that there are CPA's that seem to be trigger happy when it comes to advising their clients to take the S Corp election without educating their clients as to the implications of doing this. I'm not going to delve into the details of what an S Corp is. There is plenty of information out there on that subject and I encourage you to do your research. What I AM going to address are the issues that could get you in trouble.
But first, why would someone want their business to be taxed as an S Corp? Well, to put it simply, it's because there can be significant tax savings. "Can" is the key word here. There would have to be a few factors in play. Primarily, your business would have to be profitable enough in order for the S Corp election to provide you any benefit. Here is something to consider: it is very likely that you will not know how profitable your business will be when you are just starting out. AND, most businesses have start up costs that could result in a lower net income for the first year or two. Once you choose to be taxed as an S Corp, you must maintain that status for at least 5 years (at the time of this writing). It is ok to ask your CPA or tax professional to outline how an S Corp election would benefit YOUR business at the stage that it is currently in. It is important to be clear on why you are making this decision because it is YOUR business.
Now, for the biggest problem I come across: business owners are not told that when they choose to be taxed as an S Corp, they must become employees of their business. This boggles my mind. This is a HUGE problem. I, frankly, do not understand how this happens. Maybe the CPA just assumes that the business owner magically knows this? I'm not sure where the miscommunication happens, but this is a VERY critical thing for the business owner to know. When you choose to be taxed as an S Corp, you cannot just take owner distributions. You have to take a reasonable wage, and you can choose to take distributions in addition to the wages. If you skip the payroll part, let's just say the IRS will make sure you are very sorry that you did.
Aside from that major consequence, many business owners are not ready to run payroll, and are shocked when they realize they are supposed to be doing so, especially if they were not informed of this when they elected S Corp status. There is A LOT of paperwork involved in getting set up to run payroll. There are also going to be additional costs, which could also offset any benefits you receive from an S Corp election. You will likely need to pay for a payroll provider, and if you have bookkeeper, most bookkeepers charge extra for assisted payroll services. Payroll is not something you want to mess up on, because, again, the penalties could REALLY add up.
All of that being said, it is possible that your business is ready for that step and that having your business taxed as an S Corp could really provide some tax savings for you. I just want you, as a business owner, to be aware of what it entails and to make an informed decision. And if now is not the right time to elect to be an S Corp, that doesn't mean you can't change that later on when your business is ready.
If and when you decide that becoming an S Corp is right for your business, here are some reputable payroll providers that can also integrate with your accounting software:
If you are a small business owner and would be interested to see if my services would be a good match for your business, feel free to set up a free 30 minute consultation on my website here.
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