Can Sole Proprietors Become S Corporations?
Because sole proprietorships offer different benefits and detriments to corporations, it may be tempting to establish your business as an S corporation instead. While it’s legally allowable to create an S corporation with a single owner or shareholder, there are certain requirements that make the application, filing, and incorporation process far different from that of a sole proprietorship.
What is an S Corporation?
An S corporation is a type of corporation that is established as an entirely separate legal entity from its owners. The S corporation definition is part of what makes it so distinct from a sole proprietorship, in which the owner and legal entity are the same. This differs even further still from another type of corporation, the C corporation.
S Corp vs. Sole Proprietorship
The two largest differences between S corporations and sole proprietorships are the tax structure and legal liability. A sole proprietor is the only entity involved in this type of business, and is thus liable for any legal matters. Because the S corporation can exist as a separate legal entity, the corporation itself may protect the owner/shareholder from certain legal liabilities.
As a sole proprietor, the owner must file self-employment tax and is wholly accountable for all income. With an S corp, the tax structure is far more complicated and mandates requirements such as paying employees, even the sole owner, a reasonable salary that is then taxed under employment taxes.
How to Set up a Corporation
Whether you’re submitting an application for a sole proprietorship or learning how to apply for an S corp, you may need help working through complicated forms and ensuring compliance with legal requirements. Our simple forms can make the process completely painless. We’ll be happy to work with you to understand your options, and make the best selection for incorporating your business whether you choose sole proprietorship or an S corporation.
Many independent business owners are wondering if they are eligible to form a single-member S corporation. In short, yes, but it is no easy undertaking. This complex legal matter involves filing appropriate documents with the state, contacting the Internal Revenue System and applying for an Employer Identification Number. In addition, individuals must learn to fill out the proper forms to report income, shareholder distributions and employee payments.
While there are many legalities to follow when running your own enterprise, some may be surprised how much their business will have to change when they file for S corporation status. S corporations must have annual meetings, keep detailed minutes of each meeting and file annual reports. The best way to make sure you gain a full understanding of what this venture entails is to hire a knowledgeable business attorney.
Taxes, especially, can leave you scratching your head in confusion. Some of the tax requirements of S corporations include:
- Filing IRS form K-1 instead of paying self-employment taxes (contributions to social security and Medicare)
- Paying employees a “reasonable salary” as defined by regulations
- Paying employment taxes for salaries and corporation distributions
Just because your business is eligible for S corporation status doesn’t mean it’s the best choice to ensure financial security. Some business owners might find it valuable to be in total control of all transactions; passing tax liability onto company owners and shareholders can often have unanticipated downsides. Whatever you decide to choose, just be aware that filing IRS form 2553, Election by a Small Business Corporation, must be signed by the shareholders in order for a S corporation to not be taxed at the entity level, but at the level of the shareholders as individual tax rates on their personal income returns.
GovDocFiling can streamline the filing process to help you achieve S corporation status faster. Note that the process differs from C corporation status; businesses are required to complete Form 1120S and K-1 and individual shareholders must report income and expenses on Schedule E of the 1040 return.