Frequently Asked Questions

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Thousands of small businesses change hands every year, but often not enough money is left in the hands of the seller.  As such, we would like to share some advice about preparing your business for sale.

- Have an exit plan. Most entrepreneurs have start-up plans and growth plans, but too many

fail to prepare for the time when they want to sell the business or reduce their day-to-day

involvement.

- Know the market value of your business. Know the value in the world marketplace. Simple

formulas are often misleading and are inaccurate measures of the value of a private business.

- Explore ways to increase value. A business could be made more attractive to prospective

buyers if changes are made in the organization, key personnel, or marketing strategies.

- Understand when the market is ready. Be ready when buyers are active, money is plentiful,

and interest rates are low.

- Don’t assume the best buyer is local.

- Document the growth potential of your business.

- Consider which perks you’ll miss after selling your business. Usually the transaction can be

structured to retain those executive perks which you enjoy while meeting the buyer’s needs.

In addition to implementing these tips, be sure to work with a competent business attorney and tax

professional. This is not a time to skimp on professional help.

When starting a new business, one of the most important decisions you will make is what type of business structure to use. Among the various options available, the S corporation (S-Corp) is one that many small business owners consider. In this article, we will explore what an S-Corp really is, how it works and what benefits and drawbacks it offers to businesses.

WHAT IS AN “S-CORP?”

An S-Corp is not an entity type, but rather a type of tax election and classification that allows small businesses to avoid the double taxation that can occur with a regular corporation. Both a corporation and a limited liability company (LLC) may elect to be taxed as an S-Corp. This tax status is granted by the IRS, and a business must meet certain requirements to be eligible for it. To qualify as an S-Corp, a business must meet the following criteria:

1. The business must be a domestic entity.

2. The business must have only type of owner, which are generally individuals, estates and certain

trusts.

3. The business must have no more than 100 owners.

4. The business must have only one class of stock (or membership interest for an LLC).

An entity that has elected S-Corp tax status is a pass-through entity, which means that the business's income, deductions and credits flow through to the owners' individual tax returns. This avoids the double taxation that can occur with a regular corporation, where the corporation pays taxes on its profits and the shareholders pay taxes on their dividends.

When an S-Corp earns income, it is distributed to the owners in the form of dividends. The owners report these dividends on their individual tax returns and pay taxes on them at their individual tax rates. The S-Corp itself does not pay federal income tax, but it may still be subject to state and local taxes. One important thing to note about S-corps is that owners cannot deduct losses that exceed their investment in the company. This means that if an S-Corp has a loss, owners can only deduct their losses up to the amount of their investment in the company.

There are several benefits to operating as an S-Corp:

1. Pass-through taxation: The biggest advantage of an S-Corp is that it avoids double taxation. Since the business's income, deductions, and credits flow through to the owners' individual tax returns, there is no need to pay taxes on both the business and individual levels.

2. Limited liability protection: Like a regular corporation, an S-Corp provides limited liability protection for its owners. This means that the owners are not personally liable for the debts and liabilities of the business.

3. More favorable tax treatment: S-corps can offer more favorable tax treatment than other business structures. For example, S-Corp shareholders can take advantage of the qualified business income deduction, which allows them to deduct up to 20% of their share of the business's income.

4. Flexibility in ownership: S-corps can have up to 100 owners, which allows for more flexibility in ownership than some other business structures. This can be particularly beneficial for businesses that want to bring on additional investors or employees

While there are many benefits to operating as an S-Corp, there are also some drawbacks. S-Corps are subject to more paperwork and record-keeping requirements than some other business structures.

For example, S-Corps must file an annual tax return, and they must keep careful records of their owners' ownership percentages.

As described above, both corporations and LLCs may be taxed as an S-corp.  But for purposes of this section we'll assume we are comparing an LLC that has not elected to be taxed as an S-Corp and a corporation that has.  And since they both have pass-through taxation - where taxes are only paid once when money is distributed - what is the difference?

The primary difference is the employment tax that is paid on earnings. The owner of an LLC is

considered to be self-employed and, as such, must pay a "self-employment tax" of 15.3% which is applied to Social Security and Medicare. The entire net income of the business is subject to self-employment tax.  In contrast, an S-corp is able to pay out funds as stock dividends, which are not subject to the self-employment tax.  But keep in mind there are restrictions such as the requirement that a "reasonable" salary be paid first before dividends may be paid.

It is a popular misconception that incorporating (or organizing) a new business in states like Delaware, Nevada and Wyoming is advantageous for various reasons, including tax savings. While there are occasionally good reasons to incorporate out of your home state, in a majority of cases incorporating in the state where the business will primarily be doing business makes the most sense. First, taxes can be complicated but generally the business and/or its owners will pay taxes in the state where the income is earned, and not in its state of incorporation. Second, the business would still have to register to do business in the state in which it is operating. That means that the business would be paying registration fees in two states instead of just one. Last, incorporating in a different state would subject the business to being sued in an additional location.

How an employer defines the relationship that exists when someone performs services can have a large impact on the way a business operates. A person performing services might be an independent contractor, a statutory employee, a common-law employee, or a statutory non-employee.  An employer generally must withhold income tax, withhold and pay social security tax, and pay unemployment taxes on wages paid to an employee. A business does not usually have to withhold or pay taxes on money paid to independent contractors. 

Misclassification of the employer-employee relationship is a prime area for IRS enforcement. The IRS has targeted the “contract labor” category of payment as one which is easily and frequently abused. They are taking a serious look at anyone classified as “contract” to determine whether they have been mis-classified and should be considered an employee.

If someone is truly an independent contractor, the business contracting for services must provide a 1099-MISC. to the individual if they were paid more than $600 in the calendar year. This is the “Statement to Recipients of Miscellaneous Income,” and copies must be filed with appropriate state and federal agencies, similar to a W-2.

The employer should also be aware that most states have separate sets of guidelines on what

constitutes an employer/employee relationship. Frequently these differ from those of the federal

government. You should review both sets of applicable criteria when deciding how to classify a

worker. If you believe that your situation is unclear after reviewing the materials, you may

complete Form SS-8, and the Internal Revenue Service will make the determination for you.

Using independent contractors can be a good business decision and can save employers money in payroll taxes, employee benefits, and workers compensation costs. Nonetheless, it is worthwhile to be careful since mistakes can be costly.  An employer must have a reasonable basis for treating a worker as other than an employee. If you do not have a good reason for doing so, you may be subject to large fines and back taxes.