The Best Choice of Entity for a Small “For Profit” Business - the S-Corp

LawToolBox.com, Inc., © June 2010, All Rights Reserved.

INTRODUCTION

When an employee leaves the umbrella of protection of a company, and becomes an independent contractor or small business owner -- there are many different factors to consider in running the newly reconstituted business. One of the factors to consider is whether to be a sole proprietor, whether to incorporate your business, or whether to form an LLC (Limited Liability Company). An S-corporation is often the best choice.

WHAT’S WRONG WITH A SOLE PROPRIETORSHIP?

From a liability stand point: as a sole proprietor, if you are involved in litigation, all of your personal assets are exposed. For example, a small business owner who sells insurance is potentially exposing themselves to huge liability in the event the insured submits a claim which is denied.

In Colorado, small businesses have been sued on many theories. As some examples:

• Breach of contract with suppliers;

• Employment claims (breach of employment agreement, unpaid waged, unpaid overtime, discrimination, etc);

• Failure to deliver to client’s goods or services promised.

And from a tax stand point: as a sole proprietor, 100% of your net income is subject to wage withholding and self employment taxes.

THE CHOICE: S-CORP or LLC

Either an S-Corp or an LLC will provide (1) limited liability, and (2) reduced IRS audit exposure, while (3) maintaining the favorable flow-thru tax treatment of a sole-proprietorship or partnership (i.e., no double taxation).

RECOMMENDED: S-CORP

Forming an S-Corp creates an umbrella under which to conduct your business and offers many advantages: it minimizes your legal exposure and potentially lowers your self-employment taxes.

WHY FORM AN S-CORP?

The “corporate shield” essentially functions as one of the cheapest forms of “insurance” in the event of litigation. When you properly incorporate your business: (1) on breach of contract claims only your business assets are exposed; (2) on negligence claims based on someone else’s conduct only your business assets are exposed; but (3) on negligence or fraud claims based on your conduct all of your assets are still exposed.

In a corporation, it is possible to lower your self-employment and wage-withholding tax by receiving your income through distributions instead of as a salary. However, among other tax considerations -- reducing your taxable income also reduces the amount you may invest in tax-deferred retirement plans -- so it is important to work closely with an accountant when structuring your taxable income.
Further, doing business as an S-Corp protects your clients from claims that you are an employee of their business, preventing them from ever having to defend not withholding employee payroll taxes for you.

WHY NOT FORM AN LLC?

An LLC is the best choice when two or more partners want to distribute income not proportionate to ownership of the business, but rather on an “eat-what-you-kill” basis.
However, while the LLC is the darling of new business entities, all income from the entity will be subject to the self-employment tax. Further, conducting business as an LLC does not necessarily protect your clients from allegations that you are an employee of their business for whom they should have withheld payroll taxes. These drawbacks may outweigh any advantages found in the simplicity of LLC management.

WHY NOT FORM A C-CORP?

A C-Corporation is rarely (if ever) appropriate for a small business primarily because of the double taxation problem: the corporate books must be “zeroed out” at the end of the fiscal year or the business income will be subject to double taxation.

HIDDEN COSTS

Forming an S-Corp has hidden cost: Added paper work (wage withholding account, etc.), all marketing materials must reflect corporate status, don’t commingle personal and business assets or funds, there is some burden associated with maintaining the corporate form (i.e., holding annual meetings, keeping the corporate records in order, etc.). These costs do not outweigh the protections and benefits of forming an S-Corp to most people.

______

Non-attorneys can get help with their corporate books and can form their own business online:


or by calling1-888-958-6657