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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Michelle Moses: 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. Uh, 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.
Um, why someone would change their status. to an escort, the pluses and minuses of changing your status and how and when to do it.
So, just to discuss this, I have Jared Vanarsdale, 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 Ohlmann Company here in [00:01:00] Phoenix, Arizona. Welcome.
Jared Van Arsdale: Yeah. Thank you for having me.
Michelle Moses: Thank you so much for taking the time to be on here. Uh, Jared and I have talked many times, but we've actually never met in person until today. We're always talking on zoom about different clients and things.
And, um, I had you on because every time I talk to you, you have something, 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 talked to other people and then you always just have something. Whether we're talking about 529s or IBONs or something, you'll just always have, you're very knowledgeable.
Jared Van Arsdale: Yeah, there's plenty of, uh, examples where people make mistakes and you learn from those quickly.
Michelle Moses: Yeah, well, you're, you're very, very knowledgeable and I appreciate having you. Um, because I think a lot of people, um, that get their taxes done, they understand, they're always looking for, um, like a CPA to come up with ideas and, you know, to, you know, come with tax strategies.
And a lot of times it's just like a plug and play, um, for people getting their taxes done. And so I appreciate you and the [00:02:00] way that you brainstorm and try to problem solve. So,
Jared Van Arsdale: yeah. 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.
Michelle Moses: This is a whole nother reason I like you. Yes,
Jared Van Arsdale: there's plenty of other things on the horizon and over the horizon that you definitely want to think about when you're looking at S corps for sure.
Michelle Moses: Yeah, yeah. And taxes aren't straight. And so, and that is another thing, like when you're planning, it's not always just about saving taxes, you know, like some people will be like, Oh, I got to give all this money away.
Well, I'm like, well, you know, you don't always need to, you know, spending money is spending money just because you're saving taxes. I mean, you're still spending money. And so, 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 basically.
Whereas other people are like, no, you just need to save as many taxes as you possibly can. And that's just
Jared Van Arsdale: like the
Michelle Moses: total
Jared Van Arsdale: end goal. One example I constantly use with clients is. When you have a, uh, a demand for a reduction in taxes, you're needing credits reductions, but you're [00:03:00] always giving up something in exchange.
Ninety nine percent of the time is cash. It's like I'm giving up access to my cash by retirement deferrals. I'm giving up, uh, 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.
Right. Right. But you're still giving up the entire lot. Yeah. Give a $50,000 charit contribution. You're only getting them maybe a third of it back. Right, right. But you're still out the 50.
Michelle Moses: Right. 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 on to your cash. So sometimes, yeah. So anyway, we're not going to be talking about that.
We're going to be talking about S corp status and how you elect this. So, um, let's start at the beginning because I think, um, a lot of people are LLCs or they're 1099, you know, kind of employees, if you will.
Um, and so how do you explain this to people? Is it, do you have an easy way that you would explain this to people?
Jared Van Arsdale: Um, The easiest way to think about it is that, [00:04:00] well, first let's take a step back. The S Corps has 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 from their own hard work type of mindset. And that's, that's, you know, Where most of these small S Corps come from, right? And the number one thing they hear about is if I convert to an S Corp, I can save taxes.
But with the key understanding, it's not saving income tax. It's saving and controlling how much you pay in employment taxes. Right. That's the whole point of it. And by
Michelle Moses: employment taxes, you mean social security and Medicare, right? Okay. Exactly.
Jared Van Arsdale: So,
Michelle Moses: and so that you guys know it is four, is it 14. 7 or 15. 15.
3. Oh, I was totally okay. Not totally off, but close. Um, so it's 15. 3 percent of what you make is what you're going to pay in your, um, employment taxes. And we [00:05:00] often call it FICA taxes. You might hear people say that too.
Jared Van Arsdale: 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, the issue is that when Profitability isn't, you know, substantial enough where that 15. 3 starts getting really uncomfortable. People start thinking about this S corporation election. And, uh, we could talk about the logistics associated with it, but long story short is it's not completely eliminated.
Well, it's not supposed to be.
Michelle Moses: Right.
Jared Van Arsdale: 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.
That's where the benefit is being derived from the employment perspective.
Michelle Moses: Okay. And then, the way that I describe it too is, So you're, you, um, come up with how much you're going to pay yourself or the business is going to pay you and you're paying the [00:06:00] employment taxes on that. But then when you make money over and above what you were paying yourself, then you're taking that as a distribution because you are the owner of the company.
Is that
Jared Van Arsdale: the correct way to describe it? Okay. You have the right to do that. To the profits. Mm-Hmm. in excess of a compensation. Right? 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 DISTRI distribution.
Well, the.
We'll give you one a good example where this works out really well. Is that typically with like high net income earners from health care? Physicians and stuff this works out fantastic Because typically their rate of billing is quite an excess of what a reasonable salary would be for their same services if they were employed By a hospital right and they can take advantage of the profits, right?
The issue is is that when people set that salary too low And they still take out all the profits and they're intentionally avoiding. That is my other question
Michelle Moses: is I think I feel like people get audited because they set their [00:07:00] income at
Jared Van Arsdale: 30,
Michelle Moses: 000 or something that's completely,
Jared Van Arsdale: you know. There's a case I remember, I always like to reference it because it was a CPA who got a little Over a ski over on the East Coast, I can't remember exactly where it was, but he had set his salary at a thousand dollars a month
Michelle Moses: in the
Jared Van Arsdale: year where his like his office manager and the other people in his office were making 10 times as much as he was in, in, you know, in, or to other professional service professionals in the office.
And he had done this for like a decade before the service came on to him and then they went back and effectively, Reassess and said, you know, everything that you took out of the company as profits is actually salary to you.
Michelle Moses: Mm hmm.
Jared Van Arsdale: So we're gonna reassess. We're gonna assess the taxes. Wow. And now great.
Congratulations. You not only have Uh, gross negligence penalties associated with purpose reporting income, but you also have trust fund penalties, which is associated with employment taxes, which could be very substantial. Exactly. Yeah.
Michelle Moses: Lots of penalties. Yeah. You don't want to get audited and have penalties.
Yeah. Yeah. On
Jared Van Arsdale: the employment taxes in particular. Right. Trust fund taxes. Think of it [00:08:00] like, um, 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. Well, if you take money from them and just simply don't remit it to the state government, Those penalties can be upwards of 100 percent of the actual amount of tax, so they're designed to be incredibly punitive because you're effectively stealing from the employee, right?
Well, in this case, you're your own employee, but you're still, you're still subject to the same penalties, right?
Michelle Moses: Right. Okay. All right. Um, and so I think, and so, So that first part is very important, I think, 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 when you look at your taxes, you're still going to be effectively kind of making the same amount as you were before. It's just that you've taken out that 15 percent on a portion of your income.
Jared Van Arsdale: Yeah. So as a self employed person, it's like income minus business expenses equals net income at the whole thing.
When it says an S corporation, [00:09:00] you have two pieces. You have the wage portion, which comes in a number of double W2, like you're working for money else. Right. And then you have the, um, K1 portion, which is the schedule that your income flows through on the separate corporate tax return, which is the profits portion.
Right. And 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? Okay. But the um, But if you leave any profits in the company or you take any profits out, those profits are taxable to you regardless.
Right. So you're still paying income tax.
Michelle Moses: Even if you're just leaving, even if you're just leaving it in the account. Yeah. Even if you're
Jared Van Arsdale: leaving it in the account, but it's still coming out. Because you earned
Michelle Moses: it that year. So, I mean, that makes sense. Yeah. But if you're, you're not taking it out and putting it in your personal account and then spending it.
Yeah. Okay.
Jared Van Arsdale: 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 of the [00:10:00] corp, right, they have nothing to reclassify.
Michelle Moses: 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 like, you know, Hey, they're only paying themselves 30, 000? I mean, do you have any insight
Jared Van Arsdale: on any of that? It's more often when that line is zero. Okay. When it's, it's like a slam dunk.
Okay. So obviously zero is unreasonable. Right. Right. When it's a small amount. It's subject to facts and circumstances and, you know, example is like, um, say it's a professional firm, like a architect, right? And the managing partner is the only shareholder, right? The only officer, but he's retired. And he's just board of directors type of services, right?
And these, 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 because he's the owner, right? Everybody else is doing all the work.
Well, his salary is not unreasonable for an exchange for the [00:11:00] services that he's providing, so it's subject to facts and circumstances.
Michelle Moses: And so that kind of stuff is always where they don't want to get into. If they want more slam dunk kind of cases. Okay.
Jared Van Arsdale: Yeah, when it's zero, it's unreasonable and it's easy.
Michelle Moses: Okay. Alright.
Okay, so if this is something, if you're a business owner and you think that this is something you would want to 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? Okay. I always get the numbers. Uh, mixed up and you have to have it in by March 31st, correct, of the year?
Jared Van Arsdale: Yeah, so there's a retroactive option where you can have it by March, uh, 15th, 75 days after the year end to retroactive it to 1 1 year or any time in the future, associated usually around the 1st. 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, but it's, uh, if you're making, you have an existing entity. And we were doing it right
Michelle Moses: now, like in October, it would be for 2024. Yeah.
Jared Van Arsdale: More often than not it's elected [00:12:00] one, one.
Michelle Moses: Right. Okay. But if we were in the year, so this is what I did was whatever I was in the year, I would did it by, you know, 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. So yeah,
Jared Van Arsdale: there's late relief 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 of 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,
Michelle Moses: I had
Jared Van Arsdale: the paperwork and I had it certified mail and I just didn't send it.
Do you have a type of thing? They have late relief standards to let people qualify retroactively. Oh, okay. But there's, Specific criteria. All right. It has to be, so really get your stuff in. Just do it , it has to be really like not intentional. Yeah. Like I figured it out 14 months after the fact Uhhuh and now I want to go back.
Michelle Moses: Okay. Yeah.
Jared Van Arsdale: It has to be like, I literally did all the work. I worked with the attorney or whoever I was working with the, I just didn't file
Michelle Moses: this one little form. Exactly. And the form [00:13:00] is one page. I mean, it is, it's. Yeah.
Jared Van Arsdale: It's
Michelle Moses: like one page with some disclosures.
Jared Van Arsdale: This is my, yeah, this is my account coming in.
I think it's actually six pages with a bunch of questions and stuff, but most of it doesn't apply to everybody. Usually it's just the first page with a signature on the second page.
Michelle Moses: And I think that, um, so there, for the people that are just working with tax preparers and you know, they don't have your expertise.
Um, I do feel like it's a form that people can fill out themselves.
Jared Van Arsdale: Yeah. It's very,
Michelle Moses: yeah, it's very, very simple. So yeah. You can just go and search up, uh, you know, how to search up the form and it's on irs. gov and you download it and then you just mail it in. Um, and what I have been hearing is the IRS is not mailing out letters to say that they accepted it.
They just, they just. This is why I send it certified mail so that you know that they got it. And, um, I, I never got a notice that I was accepted to do it. And this was quite a few years ago. Yeah. Uh, and it's still kind of going on, so, um, they're supposed to, yeah, they are [00:14:00] supposed to, to, they used. Um, but you can call the IRS and, and, you know, wait on hold for a while, um, to make sure that they got it.
Um, but I just went ahead and I started doing the S Corp and it was fine. There's a
Jared Van Arsdale: little bit of risk associated with it. Usually you get a letter in the mail saying your election's been accepted and here's the effective date of it.
Michelle Moses: Right.
Jared Van Arsdale: 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. So you want to be double checked if the effective date isn't the date that you wanted. You try to file an S corporation tax return in that year.
Then it'll be rejected. It could be rejected. Yeah. Okay. Or could cause problems. Right. Okay.
Michelle Moses: So. Okay.
So the best case scenario is you want to know that they accepted it, but 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 a hundred thousand dollars, all of it is subject to FICA taxes.
All of it is subject to income [00:15:00] taxes. When you, um, change to an S corp status, you might make your, um, salary 50, 000, which makes, you know, your, so you don't have to pay FICA taxes on the other 50. Um, so it can, has the potential to save, I mean, it saves me. Thousands in taxes every year. So I definitely recommend it.
And I feel like if people are making over like 50, 000 in their business, it's something that they should probably take a look at. That's kind of the threshold that I tell people.
Jared Van Arsdale: Yeah. I usually tell them something, whatever, uh, whenever there's profits and excess of what you think is like the reasonable wage out there for those same services, you know, so it has a higher threshold for like physicians, right?
You get a position, as you said, a salary of 50, 000 because you go work, work at the local. You know, family practice and make more in that part time mindset, but certain professional services that are, you know, relatively new. Yeah, absolutely. There's a, there's definitely a lot of like flex in the determination of what your salary is [00:16:00] and where you want to be.
Like risk examination free is usually when you set that salary at or above the social security threshold, because if the service examines you, they already got all the social security taxes, which is 12. 13. 2 percent of that 15. 3 percent so they can only examine you. For the additional Medicare tax, what's the threshold?
Michelle Moses: What is the threshold on, uh, social security? It used to be like 90 changed by so much when I know so
Jared Van Arsdale: much by inflation did it's like a hundred and six Okay, so a hundred and six. Okay, so you all right usually can I talk about like high income services like law firms, you know Position practices and architectural firms, typically the salaries are well in excess of that and you like eliminate most of the examination risk as corporation.
Okay. When you have these small, disregarded entities Yeah. You have these like, um, like uh, small landscaping companies and things like that, you start getting a little. A little squishy around what a reasonable comp is because then the [00:17:00] services Mm-hmm. , you know, are definitely valued. Right. All over differently depending on the size of the company.
Yeah, exactly.
Michelle Moses: Okay. All right.
And then I think another thing we should point out is that if you do, um, elect the status is that your taxes will change. You know, you will start to do more of a, uh, like a business tax return. And then that business tax return feeds into your individual tax return. So your preparation costs and the, you know, professional fees that you pay to your CPA, um, could go up.
Um, I don't find it any more, uh, Complicated to keep track of anything, you know, from before I was an S Corp to after, um, that's all the same. It's just that the cost, um, of paying your CPA to actually prepare your taxes is higher and more, a little bit more complicated.
Jared Van Arsdale: Another reason we do that kind of cost benefit analysis, the cost of administration, the cost of having the S Corporation in existence.
There's a value, there's a cost to it, and therefore you want to make sure that the value you're receiving from planning strategies exceed that. Right. Yeah.
Michelle Moses: Yeah.
Jared Van Arsdale: Just don't get locked into it. Just, um. Think that someone [00:18:00] 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, well, that didn't save me a dime. Exactly.
Michelle Moses: Right. 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, um, like do's and don'ts that you feel like are little things that might come up that I'm missing besides that?
Cause I feel like you elected, you're still keeping track of all of your expenses and income the same way. You still give it to your CPA the same way, and then your, um, preparation fees might be a little bit more. But then you do have to file your quarterly. So I guess that is another, um, thing that comes up is you really need to do your payroll, um, at least quarterly.
Um, and that, so you're paying, um, quarterly payroll taxes, uh, and your estimated taxes at the same time. So you want to make sure that you're prepared for that. Um, but you know, normally your CPA will just send that to you and then you mail it, sign it and mail it in. So it's not. I mean, I don't feel like it's a huge burden, um, when it comes to.
Um, what am I trying to [00:19:00] say? Like bookkeeping and all of that,
Jared Van Arsdale: but you're also a little bit more analytical. That's true. I am. It's not that
Michelle Moses: big of a deal for me. So for some people it's a huge deal.
Jared Van Arsdale: Well, the adding more complication to some folks lives isn't necessarily the best strategy. Right. Okay. When they're on their way.
busy with kids or whatever, might be adding one more thing to the calendar every quarter, some might set them over the edge. So we definitely want to make sure it aligns with what they're expecting. And as long as the savings is high enough, you can typically find a way to administer it. You hire a payroll service company, right.
Michelle Moses: And
Jared Van Arsdale: don't even worry about the payment. I know. I feel like that's what most people
Michelle Moses: do is they just hire a payroll company and yeah. And then they just send it to send it automatically.
Jared Van Arsdale: Yeah.
So, some, some of the don't. So one thing to think remember is that as corporations have Significant limitations on who can be shareholders, so you definitely want to make sure that is, uh, aligned, and usually we see that become an issue with companies who are actively raising capital from outside investors, as corporations.
Definitely not.
Michelle Moses: Right? Cause [00:20:00] there's no, you're not selling any of the share, any of the stock ever, anything like that. You
Jared Van Arsdale: have issues associated with distributions. You have issues is that, you know, I want to raise capital from this investor, but he wants to hold it through his C corporation. Well, that doesn't work because it's an uneligible shareholder and it blows up dress corp.
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, uh, I'm sorry, multiple shareholders, multiple partners in this LLC, you have a equitable distribution issues. You'll say, for example, we had the same firm, we're 50, 50 partners.
We decided to take a hundred dollar distribution. You have to get 50. I have to get
Michelle Moses: 50
Jared Van Arsdale: regardless of my being on disability for the six months, I'm getting 50 still, regardless of how equitable you might think that is. Okay. That's it. One of the limitations of an S corporation is you have to have equity
Michelle Moses: industry.
So a lot of it is, is you, I, what I kind of 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 [00:21:00] little bit more complicated, you need to start looking at other
Jared Van Arsdale: legal entities. Anything that you start adding a bunch of tools.
And you add a qualified retirement plan to it or anything, you know, you need group health insurance for the employees. Everything gets a little bit more complicated when you add another Entity in the middle between you and it right type of thing. And so more commonly we see as corporations with professional services, um, entities with single shareholders, regardless of the type of enterprise, like, uh, think of a construction con large construction contractors or, uh, retail agencies, they tend to have really simple ownership structures, small businesses, but regardless of sales, right.
They typically can be in an escort with some minimal issues where you see problems arises, usually. Entities that have many different owners, partners, regardless of who's providing services or not. Yeah, I can't imagine doing
Michelle Moses: this election when there's lots of different, yeah.
Jared Van Arsdale: Because there's, and usually when you think of, um, A [00:22:00] lot of small businesses don't pay the attorney to draft an operating agreement, but when you have multiple, multiple partners, you definitely have one, or you definitely should have one.
And, uh, think of it like, uh, your, uh, premarital agreement for a business, you know, type of mindset, is that's what it's designed for. And, uh, The terms within that could blow up your S corporation election, you know, so there's a lot of little pieces when you start adding complication into it.
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.
Michelle Moses: I've never even heard anybody wanting to do that.
Jared Van Arsdale: Yeah. Really? Okay. It happens quite frequently. Yeah. That is because. More often than not, it's like we have an existing business, and that business needs real estate, or wants to purchase real estate. All the cash is here, so they want to buy the property here.
And we definitely have to try to convince them, it's like, no, hold that real estate outside. Yeah, outside in a separate LLC. If you have the ability to, definitely want to, because you lose some [00:23:00] flexibility with being able to do something with that property later that's other than selling it.
Michelle Moses: Oh, that makes sense.
Yeah. Yeah. Okay. Yeah. Well, and then you would have the property in an LLC and then you would pay rent and you kind of run it like that, right? More complication. Yeah, it is more complicated, but it's also a good write off for the depreciation and you're an expense for your business, but you're kind of paying yourself.
So, yeah. And a lot of times what I see with the S Corp is, um, the doctors, uh, and, Physicians and things like that. Um, and then what we do, and this is kind of getting out of the scope of what we're talking about, but we do an individual 401k, so they have an S corp and then we have an individual 401k. And so that might be something that you guys want to look at if you do have a business.
Um, as long as it's just you and a husband or wife, um, you can have an individual 401k. So if it's just a real simple LLC, then a lot of times that's what people have set up. Um, and then I just see you can really supercharge your. Tax savings that way. Yeah. Using,
Jared Van Arsdale: using, using any qualified retirement plan.
Yeah. Created. [00:24:00] 401k is usually pretty simple. Yeah.
Michelle Moses: The individual 401k though is so simple to set up and it's so simple. Uh, you can get so much more money in there. Let's put it that way versus like a regular IRA or a simple, you can just get a lot more into the individual 401k. So, um, okay.
So we talked about best types of business and then what about, uh, 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?
Jared Van Arsdale: Yeah. So when you're creating an S corporation, there's only two means of removing yourself from it, right?
Let's say three means the sale, which I'll come back to that. There's the succession, you know, 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.
Michelle Moses: Okay.
Jared Van Arsdale: Right. [00:25:00] And, uh, what we see sometimes with like, uh, example, a captive insurance company that decides to be in a, uh, S corporation.
Well, they can't, those captive insurance companies can't sell their books of business, so they're almost forced to liquidate because they can't, they have nothing to sell, right? Or they have an employee that's willing to take it over for them and they can kind of transfer it over and hopefully still retain some value for themselves.
But um, more often than not, you see these small businesses just liquidate, close the bank account, close the entity. That's a quick and easy, but more often than not, people don't start a business with the intent of simply just wrapping it up 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. Um, I've seen it more often with private equity buyers is that they'll have a lot more, they'll bring in [00:26:00] specialists before S corporations to verify the validity of S selections, 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, you know, Accidentally invalidated your own S election.
Michelle Moses: Okay.
Jared Van Arsdale: And they, they go, they just push you through a ringer. Because that's
Michelle Moses: 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. Well, what ends up
Jared Van Arsdale: happening, if you invalidate your S election at any point in time, after you made it, you default to a C corporation.
Oh, really? Substantially worse. Yeah. You might have to go back to your comfortable self employment life at that point. If you invalidate the S election, you're, the little background is that when you used to, prior to this, the 2553 election, we had to go through another form, make an entity to 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. It's a small while back, the service. [00:27:00] created this like check the box rule where you could just simply just jump straight to the S Corp and save them some processing power, right? And that rule, those laws still exist.
So if you invalidate your S Selection, you convert to a C Corp.
Michelle Moses: And you end up
Jared Van Arsdale: subjecting yourself to double taxation because 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. That's right. So it's really, really detrimental.
Michelle Moses: Well, and let's explain what C Corps are real quick here.
Like, cause C Corps would be, I mean, more what you're thinking of, you know, Microsoft, Apple, you know, like these huge companies that you guys all know. Those would be more. Yeah, typically
Jared Van Arsdale: they're used for people who are raising capital from outside places. Right. That's where they're most common. And then they're stock issued.
Yeah.
Michelle Moses: And then they're stock issued, but it's a lot. I mean, that's more complication than most people need.
Jared Van Arsdale: Yeah.
Michelle Moses: Yeah. Okay.
Jared Van Arsdale: Yeah. So just, that's, that's what they're coming through when you're going through like a sale of an S corporation. Those, the buyer is going to put you through, should put you through the ringer, [00:28:00] um, to verify the validity of your selection, or they're not going to buy the entity.
They might buy the assets, right? And leave you with your own company. It's like, 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.
That works out really well. And then you can just wrap up and liquidate the company. And move over. Uh, more common, uh, less common is the kind of succession plan where there's intent to transfer entity ownership to, Employees.
Michelle Moses: Mm-Hmm. .
Jared Van Arsdale: Uh, and that's a little less common. Uh, it doesn't, it happens a little bit more in professional services when there's like a, a group of physicians where they have a, a long list of, uh, partners.
Mm-Hmm. . And they can just kind of slowly allocate it to the younger generation of physicians that are being added backend. Right. You know, that happens a little bit, but more often than not, those are still formed as partnerships, but
Michelle Moses: Okay.
Jared Van Arsdale: Um, yeah. Just keep in mind, is it the most common, um. Intent [00:29:00] is sale.
Um, but if you plan on selling the company itself There's a little bit more time and hassle associated with it.
Michelle Moses: All right. But for somebody like me, I could sell my book of business. They wouldn't necessarily be buying the company. They would be buying a book of business. So yeah. More often than
Jared Van Arsdale: not, if I'm the buyer, I typically want to buy the assets.
Yeah. And the reason is because I don't want to You don't care
Michelle Moses: about the business or the name or necessarily sometimes.
Jared Van Arsdale: If the week before you, you know, ran over one of your clients in the parking lot, And the company now has a huge unstated liability or risk of future litigation, right? I don't want to buy your mess, right?
I typically just want to buy the assets and the future profits. And that's what I'm taking from you, you know? And, but sometimes it's unavoidable. Sometimes I'm forced to take the company because I don't want to rewrite a bunch of contracts with customers, or I don't want to rewrite it, but you know, think of like a software licensing company.
Right. They'd have to
Michelle Moses: re yeah. The
Jared Van Arsdale: corporation, because the licensing agreement with that software provider or whatever it might be, is with that [00:30:00] entity. And you can't simply just rewrite that contract.
Michelle Moses: Right. Right. Okay. All right.
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?
Jared Van Arsdale: Um, No, I think we've pretty much covered most of it.
Michelle Moses: Yeah. I think we've covered most of it and kind of the hows of the details of how to do it and everything. So, 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 learned from you.
So thank you. Yeah. Um, so thank you for being on and, um, you guys be sure to, uh, leave me a, um, Leave me a review. I'm totally spacing on this. Leave me a review. Um, subscribe to the podcast and thank you so much for listening and let me know if you have any questions. Um, and all of Jared's information will be in the show notes in case you wanted to get in contact with him, but thanks for listening [00:31:00] guys.
Disclaimer: The information provided in this podcast is for general informational purposes only and should not be construed as professional financial advice. Always consult with a qualified financial advisor or professional before making any financial decisions. The hosts and guests of this podcast are not responsible for any actions taken based on the information presented.