Do you freelance full-time as a contractor? Or are you a small business owner or startup? If so, you may be wondering whether you should switch your business status to an S-corp. You’ve probably heard there can be tax advantages for S-corps. Or you may be aware that you’ll be able to protect your personal assets (like your home) better if you restructure as an LLC, S-corp, or C-corp. Review the difference to know when to restructure your business.
LLCs, C-corps and S-corps
If you own a small business or startup, you should form one of the three in order to protect your personal assets. If you don’t, and you run into overdue debt, your business creditors would be able to go after your personal assets in addition to your business assets. As an LLC, C-corp, or S-corp, your business becomes a legally separate entity, and only the business is liable for its debts.
The first type of restructuring that many small business owners and freelance consultants try is reorganizing as an LLC, or Limited Liability Company. LLCs afford you the above-mentioned protection for your personal assets. You do not have to be a U.S. citizen to restructure as an LLC. And they use what are referred to as “pass through” taxes. That means you report the profits and losses for your business on your personal tax return, which can help avoid double taxation on your business.
Differences with an S-corp
An S-corp, like an LLC, shields your personal assets. It also offers some tax breaks that you don’t get with an LLC. If you restructure as an S-corp, you no longer pay self-employment tax. Furthermore, you pay yourself a reasonable salary from your profits. Then, any profits over that amount are considered dividends and taxed at a lower rate. You do have to be a U.S. citizen to restructure as an S-corp.
In order to reorganize as an S-corp, your business will first have to restructure as a C-corp. If your business will grow significantly, or have lots of investors, you will want to stay at C-corp status. You can’t file for S-corp status if you have more than 100 shareholders.
Consider making the switch to an S-corp is if you think you will probably sell your business at some point. Your taxable gains can be reduced as an S-corp.
For these and other tax-related reasons that are a bit too complicated to cover in a blog post, restructuring as an S-corp offers huge financial benefits. But there are some cases, like that of a business with more than 100 shareholders, where remaining a C-corp is the better choice. If you are thinking about making the switch to an S-corp, or restructuring at all, seek out the advice of a tax professional. There are many benefits, as well as some restrictions to consider. In addition, some of the rules surrounding these entities vary from state to state.
Here at DCA we can help answer any questions you might have about restructuring for your business.