Recently someone inquired about starting a Subchapter S Corp from their sole proprietorship, so I developed a list of key questions to ask them, as they were just told this is what they should do from someone they knew. Instead of just doing it automatically, I wanted to make sure they understood some of the basic options to consider.
*Unlike a sole proprietor (whether or not you are a LLC), you do not have self-employment tax for which you will show 15.3% on your business profit but then get a 7.65% credit that helps reduce what you owe in taxes off of that profit.
*If you are a sole proprietor, you are your business so when you are no longer working with the business, the business no longer exists. A SubChapter S continues to exist with or without you.
*A sole proprietor doesn’t have a Balance Sheet on its Form 1040 individual tax return, so it will not show anyone, including a lender, what you owe and who you owe, but a corporation tax return will.
*If you have a SubChapter S, and you sell the business, you may have to pay taxes on its sale profit unless you have losses from prior years you can apply.
*For liability protection, incorporation is key to helping protect you, but you are still responsible for your actions and those of your employees/contractors. Shareholders are only liable to the amount of their investment in the company; personal assets of shareholders are protected.
*Shareholders (up to 100) must be U.S. Residents or Resident Aliens in a corporation are based upon how much percentage they are given and do not need to be related, but a sole proprietor can only be one person or the legal spouse.
*A separate federal and state franchise tax return will need to be filed for the corporation and will cost more than a normal personal tax return with a Schedule C. All business transactions will need to be treated as a separate entity and should not be put together with the personal ones.
*Profits are passed along to each shareholder, based upon the percentage they have and must be reported onto their personal 1040 income tax return. The business is not responsible for any taxes.
*Active shareholders who own at least 2% of the business must take a reasonable paycheck.
*An Employer Identification Number must be applied for by a person who has a valid social security number.
* An Operations Agreement should be kept on file for banking and loan purposes for future use.
Dwayne J. Briscoe