Sole Prop or S-Copr, how do you file?

daniella2727 · March 2016

My husband is a small business owner. For the last several years we filed as a sole prop; however our new accountant told us a bit about how we could be structured differently as a S-Corp.

I am trying to still understand the benefits/negatives of each - any input appreciated!

hoffse · March 2016

So the pluses are corporations give you a layer of personal protection against liability. So with an S-corp you have that protection, but very generally speaking an S-corp is a flow-through entity so your tax liability should be similar to a sole proprietorship. You aren't taxed twice like C-corps are. You might even have some savings on FICA taxes and such that your accountant can talk you through.

The downside to S-corps is that they can be a pain in the butt if/when you want to sell the business. There are special rules about who the shareholders can be to maintain the S election. Practically, S-corps are fine while the business is a closely-held family company, but it can cause issues if you want to sell someday and the buyer wants to structure the deal in a way that can bust up the S election. I have spent many hours of my life trying to figure out how to not bust an S election when a business is being sold. That can become very expensive very fast.

Has your accountant talked to you about an LLC? That's my preference, personally. You get the same liability shield, but you don't have as many rules you have to follow in terms of who the members can be.

All that being said, I would never recommend running a business as a sole proprietor unless it's very low-revenue and you are super unlikely to ever get sued for anything related to it. If your H has premises that are open to the public or anything like that, go find your nearest corporate lawyer and get an LLC or corporation formed ASAP.

Also, please don't use Legalzoom or anything like that. The corporate/LLC laws are different in every state, and Legalzoom's forms are horrendous. A lot of them don't take the tax consequences into account either. Forming an LLC or corporation is pretty cheap legal work, especially if you are looking for something straightforward. Get it done right the first time.

**None of this is legal advice.

short+sassy · March 2016

When I set up my LLC, I was able to fill out the paperwork needed directly on my state's website for their Department of Revenue. After the process was done and the fee paid for, it also generated a federal tax id number for my business.

Perhaps I should have hired an attorney? Ah! I'm not sure.

hoffse · March 2016

short+sassy said:

When I set up my LLC, I was able to fill out the paperwork needed directly on my state's website for their Department of Revenue. After the process was done and the fee paid for, it also generated a federal tax id number for my business.
Perhaps I should have hired an attorney? Ah! I'm not sure.

An attorney would make sure your LLC has articles of organization and an operating agreement with the correct tax provisions, in addition to doing the name reservation, business privilege tax forms, etc. for your state. In OP's case, the attorney could also file the S election.

I have never encountered a state that will generate the federal EIN for you, but Louisiana is always the odd man out!

Actually, starting a couple years ago the IRS started requiring you to swear under penalty of perjury that you have valid permission to pull an EIN if you are a third party. We have to get a signed consent from our clients in order to pull an EIN for them. I wouldn't be surprised if LA has stopped doing them automatically for that reason.

short+sassy · March 2016

hoffse said:

short+sassy said:

When I set up my LLC, I was able to fill out the paperwork needed directly on my state's website for their Department of Revenue. After the process was done and the fee paid for, it also generated a federal tax id number for my business.
Perhaps I should have hired an attorney? Ah! I'm not sure.

An attorney would make sure your LLC has articles of organization and an operating agreement with the correct tax provisions, in addition to doing the name reservation, business privilege tax forms, etc. for your state. In OP's case, the attorney could also file the S election.

I have never encountered a state that will generate the federal EIN for you, but Louisiana is always the odd man out!

Actually, starting a couple years ago the IRS started requiring you to swear under penalty of perjury that you have valid permission to pull an EIN if you are a third party. We have to get a signed consent from our clients in order to pull an EIN for them. I wouldn't be surprised if LA has stopped doing them automatically for that reason.

I just opened it in August of last year. I'm sure the EIN number was technically generated by the IRS, because it's their letter and on their letterhead. But, from my consumer's perspective, it just felt like all part of the same process. I hear what you are saying, though, and don't have an answer on that. Other than, yeah, we seem to often be the odd ducks, lol.

The DoR site also generated my articles of organization and operating agreement. Of course it was based on the questions I answered in their form, but I was surprised at the time how easy everything was.

I'm meeting with a real estate attorney this month, primarily to prepare a lease template for me, but I also wanted to get his opinion on how best to protect my assets. Not only personal assets, but all business assets. For example, as I start to acquire more rental properties, I want to keep them separated. So if something bad happens at one property, the liability is limited to just the equity (asset) in that one property. Not the other 9.

Not that I have 9 more yet, haha. But I will someday!

hoffse · March 2016

short+sassy said:

hoffse said:

short+sassy said:

When I set up my LLC, I was able to fill out the paperwork needed directly on my state's website for their Department of Revenue. After the process was done and the fee paid for, it also generated a federal tax id number for my business.
Perhaps I should have hired an attorney? Ah! I'm not sure.

An attorney would make sure your LLC has articles of organization and an operating agreement with the correct tax provisions, in addition to doing the name reservation, business privilege tax forms, etc. for your state. In OP's case, the attorney could also file the S election.

I have never encountered a state that will generate the federal EIN for you, but Louisiana is always the odd man out!

Actually, starting a couple years ago the IRS started requiring you to swear under penalty of perjury that you have valid permission to pull an EIN if you are a third party. We have to get a signed consent from our clients in order to pull an EIN for them. I wouldn't be surprised if LA has stopped doing them automatically for that reason.

I just opened it in August of last year. I'm sure the EIN number was technically generated by the IRS, because it's their letter and on their letterhead. But, from my consumer's perspective, it just felt like all part of the same process. I hear what you are saying, though, and don't have an answer on that. Other than, yeah, we seem to often be the odd ducks, lol.
The DoR site also generated my articles of organization and operating agreement. Of course it was based on the questions I answered in their form, but I was surprised at the time how easy everything was.
I'm meeting with a real estate attorney this month, primarily to prepare a lease template for me, but I also wanted to get his opinion on how best to protect my assets. Not only personal assets, but all business assets. For example, as I start to acquire more rental properties, I want to keep them separated. So if something bad happens at one property, the liability is limited to just the equity (asset) in that one property. Not the other 9.
Not that I have 9 more yet, haha. But I will someday!

Haha good luck on getting those 9 properties!

That's crazy that LA does all of that. Does your operating agreement have all the federal tax provisions in it too? I have never touched anything in LA because it scares me. We hire people who are licensed there for reason, and the rest of us steer clear lol.

Your attorney might have you set up a different LLC for each property. That's probably what I would do. Maybe add a holding company over the whole thing.

MommyLiberty5013 · March 2016

I'm not familiar with S or C corps, but I do agree that anybody doing any sort of serious business on which their livelihood depends should NOT be a sole prop. Especially not in this I'm-gonna-sue-you-crazy society we have.

lbonga1 · March 2016

This article may help from a 'saving money on taxes' perspective.

hoffse · March 2016

Alright, I'm going to start by saying I'm really biased in the LLC vs. S-corp debate. I'm coming at it from the legal side, and I personally wish S-corps had never been created by the IRS. So there's some context for you.

Accountants tend to love S-corps because they do save you a little bit of money on your self-employment taxes. Lawyers tend to hate S-corps because the tax savings is often pretty small (not always, but often), and then you have married yourself to the S-corp rules.

So what are the rules? You can have no more than 100 shareholders. Your shareholders have to be individuals, trusts, or estates. You cannot have another corporation or partnership be a shareholder. No shareholders can be foreign persons. You can only have one class of stock. Blah, blah, blah. It's like a logic puzzle.

Without going into great detail, I can tell you that all of those restrictions in an S-corp can cause clients a lot of problems. We often have clients come in who ask us to do something the S-corp rules don't allow us to do. So then we try to find a solution that's a second-best option. But the client walks away without getting exactly what they wanted, and then they also have a big legal bill. It takes (billable) time to think through the logic puzzle and get to a work-around.

LLC's have absolutely none of those restrictions. They cost you a bit more in taxes, but then you can do pretty much whatever you want. So that's the trade-off: pay a bit more in taxes and get tons of flexibility, or pay a bit less and then play by the IRS's rules.

Now I have to take a step back and admit that there have been times I've recommended an S-corp to a client, even though I usually prefer LLCs. Sometimes their business goals really do line up just fine with the S-corp rules, and then it makes sense to save the money.

That's another reason you should talk to a lawyer, because they will be able to help you pick the best entity for your H's business. Your accountant's concern is going to be the money year-in/year-out. Your lawyer's concern is going to be what your long-term business goals are. It's good to get both perspectives.

**Not legal advice.

short+sassy · March 2016

hoffse said:

short+sassy said:

Haha good luck on getting those 9 properties!

That's crazy that LA does all of that. Does your operating agreement have all the federal tax provisions in it too? I have never touched anything in LA because it scares me. We hire people who are licensed there for reason, and the rest of us steer clear lol.

Your attorney might have you set up a different LLC for each property. That's probably what I would do. Maybe add a holding company over the whole thing.

Okay! I looked at the paperwork I received when I opened my LLC and I might be mistaken about them creating an operating agreement. I didn't see that anywhere, but I vaguely remember filling out information at the time that was for the operating agreement. The only thing I saw that was related to tax filings was on the IRS letter with my EIN.

From opening the LLC online, at the end of it, I was able to download a copy of my business license and my IRS letter with my EIN. Then, the Articles of Organization were e-mailed to me (from the LA Dept. of Revenue) either later that day or the next day. The original for my business license was snail-mailed to me.

That's one of the strategies I've read on the forums I follow for real estate investing. But, as you pointed out, laws can be very different in Louisiana than in the rest of the country so there really is no telling. Hence another good reason to see a RE attorney later this month.

daniella2727 · March 2016

I am confused. My accountant said LLC or Inc doesn't come into play here. How you FILE is either via Sole Prop or S-corp - it is how you are taxed not how you are established so confused why we would show LLC vs ...

hoffse · March 2016

daniella2727 said:

I am confused. My accountant said LLC or Inc doesn't come into play here. How you FILE is either via Sole Prop or S-corp - it is how you are taxed not how you are established so confused why we would show LLC vs ...

***************STUCK IN BOX**************

I think you are misunderstanding your accountant. You cannot file your taxes as an S-corp unless you incorporate your business (which means your business becomes a corporation) and file an S-election with the IRS. If your business is not incorporated, then your only option is to file as a sole proprietorship.

Also, an S-corp is a kind of "Inc." S-corp stands for S-corporation. A corporation is designated by "Inc.," "Co.," "Corp.," etc. in your business name. So yes, it does come into play.

hoffse · March 2016

I also think you may be confused about something else.

If your H incorporates his business, then his BUSINESS will file its own tax return each year. S-corps file an 1120S. This is a corporate income tax return. His business cannot file a corporate tax return unless it's a corporation.

However, you and your H will still continue to file your own tax return (1040) each year also. You are individuals, and therefore separate from any corporation you own.

Sole proprietorship information appears on your individual income tax return. Filing as an S-corp means filing an extra tax return each year. You can't just choose between them like how married couples can choose to file joint or separately any given year. You are talking about two completely different forms.

hoffse · March 2016

Duplicate post, sorry!

MommyLiberty5013 · March 2016

hoffse said:

I also think you may be confused about something else.

If your H incorporates his business, then his BUSINESS will file its own tax return each year. S-corps file an 1120S. This is a corporate income tax return. His business cannot file a corporate tax return unless it's a corporation.

However, you and your H will still continue to file your own tax return (1040) each year also. You are individuals, and therefore separate from any corporation you own.

Sole proprietorship information appears on your individual income tax return. Filing as an S-corp means filing an extra tax return each year. You can't just choose between them like how married couples can choose to file joint or separately any given year. You are talking about two completely different forms.

Bolded. Yes, I agree. More specifically, if your DH makes his business into a corporation, then the corporation would pay your DH a salary. He would receive his income from the actual corporation. The corporation would file its taxes as @Hoffse stated, and then you and your DH would file your taxes as a couple (either jointly or separately, however you need to do it [most married people file jointly]). The corporation would issue your DH paychecks and at the end of the year he would be issued a W2 by the corporation. Yes, he is still the owner/manager/CEO, but he would have to draw income out of the corporation. Whatever money he didn't pay himself personally would be still part of the business' profits. Separately, you would have banking accounts for the corporation that would NOT be co-mingled with your personal accounts. FYI: Even if you remain a sole prop, your banking accounts should be run separately from your personal ones.

Sole Prop or S-Copr, how do you file?

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