S-Corp Status for Your Business
Change Your LLC to An S-Corp: You Can Save Thousands
If you have your own business and earn over $50k, you'll want to listen to this episode. Electing an S-Corp tax status for your LLC might save you thousands in taxes.
Michelle Moses, CFP® and Jared Van Arsdale, CPA discuss the complexities and benefits of electing an S-Corp status.
Key Takeaways:
Who makes a good candidate for this election and how to do it.
Once elected, logistical items to consider.
Time Stamps
00:00 Welcome to the Financial Podcast: Understanding S Corps
00:37 Introducing Tax Expert Jared Van Arsdale
03:37 The Benefits and Risks of Electing S Corp Status
06:29 Navigating the Complexities of S Corp Elections and Audits
11:13 Filing for S Corp Status: Tips and Deadlines
14:30 Navigating S Corporation Elections: A Comprehensive Guide
14:38 The Financial Benefits of Electing S Corp Status
15:27 Understanding Salary Thresholds and Tax Implications
19:39 The Complexities of S Corp Shareholders and Capital Raising
24:15 Exit Strategies and Selling Your S Corporation
30:04 Concluding Thoughts on S Corporations
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S Corp Tax Savings Hook
More often than not, we tend to hear about it more from professional services. People who are those self-employed, those disregarded LLCs that are just out there hitting the ground, making as much money as they can- ... from their own hard work type of mindset. The number one thing they hear about is, "I, if I convert to an S-corp, I can save taxes."
But what the key to understanding is not saving income tax, it's saving and controlling how much you pay in employment taxes. That's the whole point of it. It's a one-page form. It is an election, so you're still an LLC, but you are being, you are electing to be taxed as an S-corp. When you change to an S-corp status, you might make your salary $50,000, which makes, your...
So you don't have to pay FICA taxes on the f- other 50. So it can, has the potential to save, it saves me thousands in taxes every year. Yeah, absolutely. So I definitely recommend it.
Podcast Intro And Guest
Welcome to the Unconventional Investor Podcast. I'm your host, Michelle Moses, certified financial planner, licensed realtor, and founder of Me Financial.
If you're an accredited investor feeling overwhelmed by managing your portfolio and looking for alternative investment strategies that go beyond the traditional stock market, you're in the right place. Let's head into today's episode so you can start taking control of your financial future. Hello, and welcome to the Me Financial Podcast.
I am Michelle Moses, your host. I'm a certified financial planner, realtor, and former e-commerce site owner. And I think today, if you are a business owner or have an LLC, this topic might be very beneficial to you. We're going to be talking about S-corps and how electing this tax status can possibly save you thousands in taxes.
Why someone would change their status to an S-corp, the pluses and minuses of changing your status, and how and when to do it. So just to discuss this, I have Jared Van Arsdale, CPA, on the show, and Jared specializes in tax compliance, planning, and examination representation for individuals, estates, and trusts.
He provides business and tax consulting and is a partner at Ollman and Company here in Phoenix, Arizona. Welcome. Yeah, thank you for having me. Thank you so much for taking the time to be on here. Yeah. Jared and I have talked many times, but we've actually never met in person until today. Yeah. We're always talking on Zoom about different clients and things.
And I had you on because every time I talk to you, you have something, the, it, like a bit of knowledge that I've never, ever heard from anybody else. Yeah. So I just want to give you kudos to that, that I talk to other people, and then you always just have something- Yeah ... if, whether we're talking about 529s or I bonds or something, you al- just always have...
You're very knowledgeable. Yeah, there's plenty of examples where people make mistakes, and you learn from those quickly. Yeah. You're very knowledgeable, and I appreciate having you because I think a lot of people that get their taxes done, they understand, they're always looking for like a CPA to come up with ideas and to, you know- Yeah
come with tax strategies, and a lot of times it's just like a plug and play for people getting their taxes done. And so I appreciate you and the way that you brainstorm and try to problem solve, yeah. Yeah. Yeah.
Tax Planning Mindset
W- at the firm, we try to do our best to make sure that we're, aligning- people's expectations of what their actual goals are, and not necessarily income tax savings, 'cause income tax savings is a one-year issue, right?
This is a whole nother reason- Yeah ... I like you, yes. There there's plenty of other things on the horizon- Yes. ... And over the horizon that you definitely want to think about when you're looking at S-corps, for sure. Yeah. And taxes aren't straight, and ... And that is another thing, like when you're planning, it's not always just about saving taxes.
Like some people will be like, "Oh, I got to give all this money away." I'm like you don't always need to ... spending money is spending money. Just because you're saving taxes- Yeah ... you're still spending money." And so you're one of the only CPAs that I know that is like, "Yeah, I don't know that you need to spend that."
You agree with me- Yeah ... basically, whereas other people are like, "No, you just need to save as many taxes as you possibly can." Yeah. And that's just like the total end goal. One, one example I constantly use with clients is when you have a a demand for a reduction in taxes, you're needing credits, reductions, but you're always giving up something in exchange.
99% of the time it's cash. It's like I'm giving up access to my cash by retirement deferrals. I'm giving up access to my cash by making large charitable contributions, whatever it might be. You're usually giving up something in exchange, and you're getting just a piece of it back- from the tax code. But you're still giving up the entire lot. Yeah. You give a $50,000 charitable contribution, you're only getting maybe a third of it back. But you're still out the 50. Yeah. That's a great way to look at it. Yeah. And that sometimes that there's a reason that the saying is cash is king, right?
And so sometimes it's just nice to hold onto your cash, sometimes it is. Yeah. So anyway, we're gonna, not gonna be talking about that.
S Corp Basics Explained
We're gonna be talking about S-corp status and how you elect this. Let's start at the beginning because I think a lot of people are LLCs, or they're 1099, employees, if you will.
And so how do you explain this to people? Is it, do you have a easy way that you would explain this to people? The easiest way to think about it is that first let's take a step back. The S-corp's been around for quite a while, right? And so more often than not, we tend to hear about it more from professional services.
People who are those self-employed, those disregarded LLCs that are just out there hitting the ground, making as much money as they can- ... [00:05:00] from their own hard work type of mindset, and that's- Where most of these small S-corps come from. And the number one thing they hear about is, "I- if I convert to an S-corp, I can save taxes," but what the key to understanding, it's not saving income tax, it's saving and controlling how much you pay in employment taxes.
That's the whole point of it. And by employment taxes, you mean Social Security- And Medicare ... Medicare. Okay. Exactly. So- And so that you guys know, it is four- Is it 14.7 or 15.7? 15.3. It's 15.3. Oh, I was totally... Okay. Yeah. Not totally off, but close. In the range. So it's 15.3% of what you make is what you're gonna pay in your employment taxes, and we often call it FICA taxes.
You might hear s- people say that, too. Yeah. So as a self-employed person, you're paying the full 15.3 on net business income- ... regardless of other deductions, right? So the issue is that when- profitability isn't sub- you know, substantial enough where that 15.3 starts getting really uncomfortable- people start thinking about this S-corporation election. And we could talk about the logistics associated with it, but long story short is it- it's not completely eliminated. It's not supposed to be. But it's within control, so you have to choose, as an S-corporation, you are no longer self-employed.
You are employed by your own corp. And that corporation has to pay you a wage. Now you get to choose how much of those employment taxes you pay versus paying it regardless on the total net income from the business. And that's where the benefit is being derived from the employment perspective.
Okay. And then the way that I describe it, too, is so you're- you come up with how much you're gonna pay yourself or the business is gonna pay you, and you're paying the employment taxes on that. But then when you make money over and above what you are paying yourself, then you're taking that as a distribution because- you are the owner of the company. Correct. Is that the correct way to describe it? Yeah.
Reasonable Salary Rules
In fact- Okay ... in fact, I would use you have the rights to the profits- ... in excess of a compensation, right? The service doesn't define compensation. It doesn't define exactly what it is. That's where your risk comes in as an employer.
You have to define what reasonable compensation is, but the excess profits are there for the distr- distribution. The, We'll give you one g- example where this works out really well is that typically with high net income earners from healthcare- ... think of physicians and stuff, this works out fantastic 'cause typically their rate of billing is quite in excess of what a reasonable salary would be for their same services if they were employed by a hospital.
And they can take advantage of the profits, right? The issue is that when people set that salary too low and they still take out all the profits and they're intentionally avoiding the employment taxes- That is my other question, is I th- I feel like people get audited because they set their income at- Yeah
$30,000 or something- Yeah ... that's completely, you know- there's a case I remember. I always like to reference it because it was a CPA who got a little over his skis. Yeah. It was somewhere on the East Coast. I can't remember exactly where it was, but he had set his salary at $1,000 a month- Oh, my gosh
or $12,000 a year. Yeah. Where his his office manager and the other people in his office were making 10 times as much as he was in, in r- regards to other professional service- professionals in the office, and he had done this for a decade before the service came onto him.
Audit Risks And Penalties
And then they went back and effectively reassessed and said, everything that you took out of the company as profits- is actually salary to you." "So we're gonna reassess. We're gonna assess the taxes." Wow. And now great, congratulations. You not only have- gross negligence penalties associated with purposely- ... reporting income, but you also have trust fund penalties, which is associated with employment taxes- Oh, boy
which could be very substantial. Exactly. So yeah. Yeah. Yeah. Lots of penalties. Yeah. Yeah, you don't wanna get audited and have penalties. Yeah. Yeah. Those are on the employment taxes in particular- ... because trust fund taxes, think of it like if you employ somebody, you're required to withhold money from their paycheck and give it to the IRS and Department of Revenues and things to that effect.
If you take money from them- ... and just simply don't remit it to the state- ... or the government, those penalties can be upwards of 100% of the actual amount of tax. So they're designed to be incredibly punitive, 'cause you're effectively stealing from the employee. In this case, you're your own employee.
But you're still stealing. But you're still subject to- Yeah ... the same penalties. Yeah. Okay. All right.
W2 Vs K1 Income Split
And so I think- And that first part is very important, I think- Yeah ... of not setting your salary too low, and I think it's also important to point out that the distributions that you're taking, you still are paying income tax on that.
So it... When you look at your taxes, you're still going to be effectively making the same amount as you were before, it's just that you've taken out that 15% on a portion- Yeah ... of your income. Yeah. So as a self-employed person, it's like income minus business expenses equals net income. You have the whole thing.
When it's an S-corporation, you have two pieces. You have the wage portion, which comes in the number of W- W-2, like you're working for anybody else. And then you have the K-1 portion, which is the schedule that your income flows through on the separate corporate tax return- ... which is the profits portion.
The key to understand is that you don't have to take the profits out, and that's actually one way to minimize the examination risk, is by leaving the excess profits in the company. Oh, really? But- Okay ... but the, But if you leave any profits in the company or you take any profits out, those profits are taxable to you regardless.
So you're still paying income tax- Even if you're just leaving- ... on the total amount ... even if you're just leaving it in the account. Yeah, even if- ... you're leaving it in the account, but it's still coming out- Because you earned it that year. Exactly. So that makes sense. Yeah. But if you're not taking it out and putting it in your personal account and then spending it.
Yeah. Okay. Yeah. Yeah, the examination risk of this service will challenge when people take distributions from their corporation- ... the profit distributions, and intentionally do not call that salary, right? But if you never take the money and it stays inside the corp, right- ... they have nothing to reclassify.
Okay. So that's why it lowers the examination risk. Okay. And so do you think that they're going through and flagging people that hey, they're only paying themselves 30,000? Do you have any inc- it's- ... insight on any of that? It's more often when that line is zero. Okay. It's when it's like a slam dunk.
Okay. 'Cause obviously zero is unreasonable. The... When it's a small amount, it's subject to facts and circumstances. Example is say it's a professional firm like a architect, right? And the managing partner is the only shareholder the only officer, but he's retired and he's this board of directors type of services.
And they s- you know, the collectively the group says, "You know what? We still need him, so we'll give him a really small salary." It's called that thousand a month again But he's not providing any services to the company. He's only getting profits- ... 'cause he's the owner, right? Everybody else is doing all the work.
His salary's not unreasonable for an exchange for the services- ... that he's providing. Okay. So it's subject to facts and- Okay ... circumstances. And so that kind of stuff is always where- Yeah ... they don't wanna get into. When it's zero, yeah. But they want more slam dunk- Yeah ... kind of cases. Okay. Yeah, when it's zero, it's unreasonable, and it's easy.
Okay. Yeah. All right.
How To File Form 2553
Okay, so if this is something, if you're a business owner and you think that this is something you would wanna do, the way to elect it is to file a form, and I always get the number wrong. Is it 2553? You got it. Is that right? Yeah. Okay, I always get the numbers mixed up, and you have to have it in by March 31st, correct, of the year?
Yeah, so there's a retroactive option where you- ... can have it by March 15th, 75 days after the year end- Okay ... to retroactive it to 1/1- Okay ... of the calendar year or any time in the future, so say usually around the first. But the only exception to that is if you have a brand-new company. You set up a new company, and you immediately incorporate it and make an election, you can have the election at any point during the year.
Okay. But it's if you're make- you have an existing entity, an existing business- And we were doing it right now, like in October, it would be for 2024. Yeah, more often than not- ... it's elected 1/1. Exactly. Okay. But if we were in the year, so this is what I did, was I- whatever I was in the year, I would, did it by, in February when I was doing my taxes, and I did it retroactively for the year that I hadn't done my taxes for.
Yeah. Okay.
Late Elections And IRS Proof
Yeah, so there's late relief excent- exemptions- ... where you can go back- ... into the previous year. There's a revenue procedure. Don't quote me. I don't remember the number off the top of my head. I always have to look it up, but there's a couple revenue procedures that allow people to say, "You know what?
I've been operating like as if I were an S-corporation for this entire year, and I just realized I, you know- ... I had the paperwork, and I had it certified mail, and I just didn't send it," that type of thing. They have late relief standards- Okay ... to let people qualify retroactively. Oh, okay. But there's specific criteria.
All right. It has to be- So really get your stuff in ... it, it- Just do it. It has to be really not intentional. Yeah. I figured it out 14 months after the fact- ... and now I wanna go back. Okay, yeah. It has to be like, "I literally did all the work. I worked with the attorney," or whoever I was working with to put this together.
I just didn't file this one little form. Exactly. And the form is one page. It is, it's- Yeah, it's- It's one page with some disclosures this is my... Yeah, this is my- ... accountant coming in. I think it's actually six pages- Is it? Okay ... with a bunch of questions and stuff like that. Yeah.
But most of it doesn't apply to everybody. So usually it's just the first page with a s- signature on the second page. Yeah. And I think that so there, for the people that are just working with tax preparers and, they don't have your expertise- ... I do feel like it's a form that people can fill out themselves.
Yeah. I would- I, it's very s- ... never advise people to fill it out themselves ... yeah, it's very simple. So you can just go and search up how to, search up the form, and it's on irs.gov, and you download it, and then you just mail it in. And what I have been hearing is the IRS is not mailing out letters to say that they accepted it.
They just ex- they just... This is why I send it certified mail, so that you know that they got it. And I never got a notice that I was accepted to do it, and this was quite a few years ago. Yeah. And it's still going on. You- They're supposed to Yeah, they are supposed to. They used to.
But you can call the IRS to, and wait on hold for a while to make sure that they got it. But I just went ahead and I started doing the S-corp and- Yeah ... it was fine. There's a little bit of risk associated with it. Usually, you get a letter in the mail saying- Yeah ... your election's been accepted, and here's the effective date of it.
Sometimes when the form isn't completed correctly, the effective date isn't the date you actually chose. Okay. And they'll move it out a year or something like that. Oh, okay. And so you want to be double checked because- Yeah ... if the effective date isn't the date that you wanted, you try to file an S-corporation tax return that year- Then it'll be rejected
They could be rejected. Yeah, okay. Or could cause problems. Exactly. Okay. Okay.
S Corp Tax Savings
So the best case scenario is you want to know that they accepted it. But- Yeah ... anyway, it's a one-page form. It is an election, so you're still an LLC, but you are being, you are electing to be taxed as an S-corp. So when you're an LLC, all of your income is coming in.
So let's say you made $100,000. All of it is subject to FICA taxes. All of it is subject to income taxes. When you change to an S-corp status, you might make your salary $50,000, which makes, your... So you don't have to pay FICA taxes on the f- other 50. So it can, has the potential to save, it saves me- Yeah
thousands in taxes every year. Yeah, absolutely. Yes. So I definitely recommend it. And I feel like if people are making over $50,000 in their business it's something that they should probably take a look at. Yeah. That's the threshold that I tell people.
Reasonable Salary Rules
Yeah, I usually tell them something, whatever whenever there's profits in excess of what you think is the reasonable wage out there for those same services.
So it has a higher threshold for physicians. That's true. Physician is- Yeah ... gonna set a salary of 50,000- Yeah ... because you go work, work at the local, family practice and make- ... more in that part-time- ... part-time mindset. But certain professional services that are, relatively new- yeah, absolutely. There's there's definitely a lot of, like- flex in the determination of what reasonable is Of what your salary is, yeah And where you wanna be, like, risk examination-free is usually when you set that salary at or above the Social Security threshold. Because, and then if the service examines you, they already got all the Social Security taxes, which is w- 12, 13.2% of that 15.3.
So they can only examine you for the additional Medicare tax- What's the threshold- ... which is so small ... what is the threshold on Social Security? It used to be, like, 90. Oh, it changed by so much. It went up- I know ... it went up so much by inflation. Did it? I think it's 160- Okay ... or 70,000. So 106 or s- okay. All right So you s- that's, usually, like, when I talk about h- high income services like law firms, physician practices and th- architectural firms, typically, the salaries are well in excess of that, and you can eliminate most of the examination risk- Okay ... when you have S-corporation.
Okay. When you have these small disregarded entities, like- Yeah ... you have these small landscaping companies and things like that, you start getting a little squishy around what a reasonable comp is because then the services- ... are definitely- ... filed differently- All over
depending on the size of the company. Yeah, exactly. But- Okay. All right.
Costs And Admin Tradeoffs
And then I think another thing we should point out is that if you do elect this status is that your taxes will change. You will start to do more of a a business tax return, and then that business tax return feeds into your individual tax return.
So your preparation costs and the, professional fees that you pay to your CPA could go up. I don't find it any more complicated to keep track of anything, from before I was an S-corp to after. That's all the same, it's just that the cost of paying your CPA to actually prepare your taxes is higher- Yeah
and more, a little bit more complicated. Another reason when you do that kind of cost-benefit analysis- Yeah ... the cost of administration, the cost of having the S-corporation in existence there's a va- there's a cost to it, and therefore, you wanna make sure that the value you're receiving from- your planning strategies exceed that. Yeah. Just don't elect into it just to think that someone told you, "This is what you need to do," and then it ends up costing you a few thousand dollars, and you're just like that didn't save me a dime." Exactly. 'Cause if you set your salary at 40 and you're only making 50 in your business, then it's not really worth it.
Yeah. And so are there other dos and don'ts that you feel like or little things that might come up that I'm missing besides th- 'cause I feel like you elect it, you're still keeping track of all of your expenses the s- and income the same way. Yeah. You still give it to your CPA the same way, and then your preparation fees might be a little bit more.
Yeah.
Payroll And Quarterly Filings
But then you do have to file your quarterly, so I guess that is another thing that comes up- The payroll administration ... is you really need to do your payroll at least quarterly. And then so you're paying quarterly payroll taxes and your estimated taxes at the same time. So you wanna make sure that you're prepared for that.
Normally, your CPA will just send that to you, and then you mail, sign it, and mail it in. Yeah. So it's not it, I don't feel like it's a huge- ... burden when it comes to what am I trying to say? Bookkeeping and all of that. But you're also a little bit more analytical.
That's true. Yeah. I am. It's not that big of a deal for me, it can- It, for some people, it's a huge deal ... ex- the adding more complication to some folks' lives isn't necessarily the best strategy. Okay. When they're busy with kids or whatever it might be, adding one more thing to the calendar every quarter- some might set them over the edge. Okay. So you definitely wanna make sure it aligns with what they were expecting. And as long as the savings is high enough, you could typically find a way to administer it. You hire a payroll service company. Don't even worry about the payroll. I know. Just send them the dollar amount.
I feel like that's what most people do, is they just hire a payroll company- Yeah ... and- For sure. Yeah, and then they- Yeah ... just send it to, send it automatically. Yeah.
Shareholder Limits Pitfalls
So some of the don'ts. So one thing to think, remember is that S-corporations have s- significant limitations on who can be shareholders.
So you definitely wanna make sure that is aligned. And usually we see that become an issue with companies who are actively raising capital- Okay ... from outside investors. S-corporation is definitely not- ... where you wanna be 'Cause there's no, you're not selling any of the share, any of the stock- Yeah
ever or anything like that. I think you have issues associated with distributions, you have iss- issues is that, I wanna raise capital from this investor, but he wants to hold it through his C corporation. That doesn't work because it's an uneligible shareholder, and it blows up your S-corp.
The whole, everything becomes a problem. So just keep trying to keep it simple is that there's limitations on who can be shareholders, right? There's issues if you have multiple companies, you think I'm sorry, multiple shareholders, multiple partners in this LLC. You have equitable distribution issues.
Say for example, we had the same firm. We're 50/50 partners, we decide to take $100 distribution. You have to get 50, I have to get 50. Regardless of my being on disability for the six months, I'm getting still. Regardless of how equitable you might think that is, that's it, one of the limitations of an S-corporation- Okay
is you have to have equitable distribution. So a lot of it is you, I- I, what I kinda hear you saying is that when you have a simpler setup- For sure ... then the S-corp seems to be beneficial, but once you start to get a little bit more complicated, you need to start looking at other- Yeah, you start- ... entities
adding anything that you start adding a bunch of tools- Yeah ... employ- You add a qualified retirement plan to it or anything, you need group health insurance for the employees, everything's gets a little bit more complicated- ... when you add another entity in the middle between you and it- type of thing. And so more commonly we see S-corporations with professional services entities with single shareholders, irregardless of the type of enterprise. Think of a construction con- large construction contractors or a lot of retail agencies. They tend to have really simple ownership structures small businesses, but regardless of sales, right? They typically can be in an S-corp with some minimal issues. Where you see problems arise is usually entities that have many different owners, partners, regardless of who's providing services or not usually Yeah, I can't imagine doing this election when there's lots of different, yeah because there's t- and usually when you think of y- A lot of small businesses don't pay the attorney to draft an operating agreement.
But when you have multiple partners, you definitely have one- ... or you definitely should have one. And think of it like your premarital agreement for a business- ... type of mindset- ... is that's what it's designed for, and it, the terms within that could blow up your S-corporation election.
Okay. So there's the- Yeah, there's just a lot of- There's a lot of little pieces- Yeah ... when you start adding complication- ... into it.
Real Estate In Separate LLC
And one of the number one things we tell, definitely tell clients to avoid is holding real estate in S-corporations. That is definitely not I've never even heard anybody wanting to do that.
Yeah. Really? That, yeah. Okay. It happens quite frequently. Yeah. Is because more often than not, it's like we have a existing business, and we, that business needs a real estate, has a, or wants to purchase real estate. The, all the cash is here, so they want to buy the property here, and we definitely have to try to convince them.
It's "No, hold that real estate outside." Yeah, outside- Have a separate- ... in a separate LLC. If you have the ability to, definitely want to. Because you lose some flexibility with being able to do something with that property later that's, other than selling it. Yeah. Oh, that makes sense. Yeah. Yeah.
Okay. Yeah and then you would have the property in an LLC, and then you would pay rent, and- ... you would run it like that, right? We're adding more complication. Yeah, it is more- ... complicated, but it's also a good write-off for the depreciation, and you, an expense for your business- Yeah
but you're paying yourself. Yeah. So yeah.
Solo 401k Boost
And a lot of times what I see with the S-corp is a lot, the doctors and physicians and things like that. And then what we do, and this is getting out of the scope of what we're talking about, but we do an individual 401. So they have an S-corp, and then we have an individual 401.
And so that might be something that you guys want to look at if you do have a business. As long as it's just you and a husband or a wife you can have an individual 401. So if it's just a real simple LLC, then a lot of times that's what people have set up. And then I just see you can really supercharge your tax savings that way.
Yeah. Yeah. Using any qualified retirement plan- Yeah ... to create a dif- Well- Yeah ... a 401is usually pretty simple to set up- Yeah, the individual 401though is so simple to set up, and it's so simple. Yeah. You can get so much more money in there. Yeah. Let's put it that way, versus a regular IRA or a simple.
You can just get a lot more into the individual- Yeah ... 401, sure.
Exit Plans And Due Diligence
Okay, so we talked about best types of business, and then what about exit strategies? Is there anything that you have to worry about, like, when you're... Let's take me, okay? So let's pretend I'm older, and I'm an S-corp, and I'm going to sell my business.
Is there something to worry about when I'm trying to exit my business or anything like that, or what do you see? Yeah, so when you're creating an S-corporation, there's only two means of removing yourself from it, right? Or let's say three means. The sale, which I'll come back to that. There's the succession, bring somebody else in and let them effectively take over.
Redeem your ownership or whatever it might be, and then there's just a straight up liquidation and close the company. Okay. And what we see sometimes with a example, a captive insurance comp- that decides to be an S-corporation. They can't s- those captive insurance companies can't sell their books of business, so they're almost forced to liquidate- Okay
'cause they can't, they have nothing to sell. Or they have an employee that's willing to take it over for them, and they can transfer it over and hopefully s- still retain some value for themselves. But more often than not, you see these small businesses just liquidate. Close the bank account, close the entity, be done.
That's quick and easy. But more often than not, people don't start a business with the intent of simply just wrapping it up- ... with that type of thing. They're looking to create some value and then sell it to fund their own retirement plans or whatever it might be. So one thing to think about when you have an S-corporation is if you're planning on selling this entity, if it's your overall long-term goal is to sell to a third party, typically you have a little bit more due diligence in the sale.
I've seen it more often with private equity buyers- ... is that they'll have a lot more, they'll bring in specialists with, for S-corporations to verify the validity of S elections. Regardless of how far it goes back, they go through years and years of tax returns to make sure there's no instances where you could have accidentally invalidated your own S election.
Okay. And they go, they just put you through a ringer a little bit more.
Invalid Election Becomes C Corp
Because that's really important to the ... Because if you didn't have it and they purchased the company, then they could be on the hook for it- what- ... is what you're saying ... ends up happening, if you invalidate your S election at any- point in time after you made it- ... you default to a C corporation. Oh, really? Which is subs- substantially worse. Yeah. You don't get to go back to your comfortable self-employment life- ... after that point. If you invalidate the S election, your, the ... a little background is that when you used to w- prior to this, the 2553 election, we had to go through another form, make an entity be classified as a C corp, and then you'd make a second election to be classified as an S-corp.
It's a small businesS-corporation- ... instead of a regular. So you had to do a two-step process. A while back, the service created this check the box rule where you could just simply just jump straight to the S-corp and save them some processing power. Okay? And that rule's, those laws still exist.
So if you invalidate your S election, you convert to a C corp- Oh, man. That would be- ... and you end up subjecting it, subjecting yourself to double taxation- Yeah ... 'cause the C corp pays its own taxes, and if you ever take any money out of the C corp, you pay taxes on that distribution as well. And so it's really detrimental.
And let's explain what C corps are real- Yeah ... quick here. 'Cause C corps would be, more what you're thinking of. Microsoft, Apple, like these huge companies that you guys all know. The, those would be more- Yeah. Ty- Yeah ... typically, they're used for people who are raising capital from outside places.
That's where they're most common. And then there's stock issued. There's some really old ones. Yeah. Yeah. Yeah, there's- And then there's stock issue, but it's a lot ... that's more complication than- For sure ... most people need. Yeah. Yeah. For sure. Okay. Yeah, so just that's what they're coming through.
When you're going through a sale of an S-corporation, those, the p- the buyer is gonna put you through, should put you through the ringer- ... to verify the validity of your S election, or they're not gonna buy the entity. They might buy the assets and leave you with your own company. It's "Hey, you know what? You have a book of business, right? We'll buy the book of business, but you get to keep your company and all the mess you created in the past, and we'll just take the assets, and we'll give you a check for it." Okay. That kind of mindset. That works out really well, and then you can just wrap up and liquidate the company and move over.
A more common less common is the kind of the succession plan where there's intent to transfer entity ownership to employees. And that's a little less common. It doesn't, it happens a little bit more in professional services when there's a group of physicians where they have a s- a long list of partners.
And they can just kinda slowly allocate it to the younger generation of physicians that are being added back end. That happens a little bit, but more often than not, those are still formed as partnerships. But- Okay ... yeah, just ke- keep in mind is that the most common intent is sale.
But if you plan on selling the company itself, there's a little bit more time and hassle- Okay ... associated with it. All right. But for somebody like me, I could sell my book of business. They wouldn't necessarily be buying the company. Correct. They would be buying a book of business. And well- yeah.
Yeah.
Asset Sale Versus Stock Sale
I mean- More often than not, if I'm the buyer- ... I would typically wanna buy the assets. Yeah. And the reason is 'cause I don't wanna- You don't care about the business or the name or- if- ... necessarily sometimes ... if the week before you, ran over one of your clients in the parking lot, and the company now has a huge unstated liability or risk of future litigation- I don't wanna buy your mess. Yeah. I typically just wanna buy the assets- ... and the future profits, and that's what I'm taking from you. Okay. And but sometimes it's unavoidable. Sometimes I'm forced to take the company because I don't wanna rewrite a bunch of contracts with customers, or I don't wanna rewrite a...
think of a software licensing company. They'd need- They'd have to res- yeah ... they'd need the corporation because the licensing agreement with that software provider or whatever it might be is with that entity, and you can't simply just rewrite that contract. Yeah. Okay.
All right.
Wrap Up And Next Steps
Do you feel like there's anything that we're missing that comes up a lot with the S-corp election or anything like that? No, I think we pretty much covered most of it. Yeah. Yeah. I think we've covered most of it and the hows of the details of how to do it and everything and I had no idea.
See, this is what I'm talking about. I've never, ever heard of going from an S-corp to a C corp if you mess it up, so I always have... There's always a little tidbit that I learn from you, so thank you. Yeah. So thank you for being on, and leave me a review. Subscribe to the podcast, and thank you so much for listening.
And let me know if you have any questions. And all of Jared's information will be in the show notes in case you wanted to get in contact with him. Thank you for listening to the Unconventional Investor Podcast. I hope you feel more confident in how you can grow your wealth using the strategies I shared in this episode.
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