“S” verses “C” Strategy
Most small companies start out as a sole proprietorship which is the easiest and most economical way to start business. It takes 3 to 5 years for any business to mature and to become profitable. Sole proprietorships file their tax returns together with the owner’s individual return on Schedule C. This income is included with all the other income and income taxes are computed together. In addition to income tax, there is a 15.3% tax for Social Security tax and Medicare tax.
It is on Schedule C that all the details of sales and expenses related to the business are reported. The IRS has record of all these details and has an audit program that analyzes these numbers to determine whether it should be audited. There is an audit risk, as a result.
It is our recommendation that sole proprietorships incorporate their business to shield themselves legally, reduce their audit risk, and to take advantage of tax benefits that are available to them. Making the election to be taxed as an S corporation is part of this strategy since S corporations are not subject to the 15.3% tax. There is a cost to incorporating the business as well as maintaining it on a year-to-year basis. Consequently, we recommend that a company show profits of at least $60,000 before considering incorporating their business.
To qualify for the S corporation status, the owners of the company must be considered a permanent resident of the United States. This means that you must have a Green Card or an E2 status.
If you would like us to run an analysis to calculate the tax savings you could be receiving, we provide this service at no charge. The S status can be retroactively applied to be effective for 2020 and 2021. Please contact our office if you are interested in having this tax analysis done.