S Corp. or sole proprietor

[MikeTurnrose]

I was wondering of those with very small companies out there (1-4 persons) that have incorporated as an S Corp. is it worth the up front fees and maintenance time involved in potential tax savings? What are the pros and cons of becoming an S Corp?

Thanks.

[Jim Frame]

What are the pros and cons of becoming an S Corp?

I chose sole proprietorship because at the time I didn't perceive any benefit to incorporating. There's no professional liability protection, and given the propensity of the courts to pierce the corporate veil I'm not sure there's any significant general liability protection.

It's been a long time since I've looked into it, so I'd be interested in hearing from some incorporated folks who may have a better handle on the benefits.

[land butcher]

I'm not so sure about what Jim says. Every developer has each project under a separate corp name.
I never did inc but AFAIK it keeps your personal property out of the business liabilities, or at least make it real hard to get to.

[dmi]

Is you home an asset of the S corp. ? Nothing prevents you from being liable, but an S corp should provide asset protection that you do not have as a sole proprietor.

[Jim Frame]

an S corp should provide asset protection that you do not have as a sole proprietor

*Some* protection, yes. But *enough* protection to make the added cost and administrative burden worthwhile?

Some of the situations in which a court may decide to reach beyond corporate protection to expose personal assets:

Personal funds are intermingled with corporate funds.
The corporation fails to have director and shareholder meetings.
The corporation has minimal capitalization or minimal insurance.
The corporation fails to pay state taxes or otherwise violates state law (like defrauding customers).

It's really easy to do some of the above when you're an uber-small operation.

And, as noted before, professional liability isn't shielded by incorporation.

Finally, one of the touted advantage of incorporation is that you can avoid paying some or all of the self-employment tax that sole proprietors pay. That's a really attractive option, right up until you retire and find that you have no Social Security income as a result of not contributing to the program. If you're a reasonably astute and disciplined investor, you can probably do as well or better by investing the SE tax money yourself. But you have to avoid the temptation to spend that money.

Everyone has a different comfort level with this stuff. For me, sole proprietorship backed by good insurance coverage is the way to go.

[MikeTurnrose]

Thanks for your responses.

So is the tax savings solely in the SE tax? Is there any benefits in income/corporate tax?

[dmi]

Jim, 75 percent of the ways around the vail ,that you listed, are either illegal or simply poor business practice. Profit from the corporation is passed thru to the owners and taxed as ordinary income. The corporation pays the employer share of the employer taxes and you pay your share. No tax advantage there...
There really is not a lot of work to set up and maintain the corporation. How difficult is it for the directors to meet when you are all of them?

[Jim Frame]

The SE tax "advantage" is accomplished by passing the income through as dividends rather than salary, or so I'm told.

[dmi]

There is no ssi or fica on the dividend, but they are taxed at your ordinary income level. Having said that, you have to pay yourself and you have to pay all the employment taxes before you can have a dividend....

[Jim Frame]

you have to pay yourself and you have to pay all the employment taxes before you can have a dividend

But are there any restrictions on how little you can pay yourself, e.g. can you set your annual salary at $1.00 and declare the rest as dividends?

[dmi]

Jim, they saw that move coming and they have rules in place. They look at industry standards for salaries. So the $1 a year salary won't work, they can /will come after you for the employer taxes at some point...

[land butcher]

A CE I knew, now deceased, was incorporated as a NV corp. And his last annual stockholders meeting was held in Paris France. So there are advantages in addition to personal asset protection.
If personal protection wasn't there there would be a lot of big company CEOs living under bridges or in jail.