Minnesota S-Corp FAQ: Benefits, Disadvantages, Taxation & Formation

S Corp Basics

S Corp is short for “S Corporation.” Technically, an S Corp is a corporation that has elected S Corp tax treatment under Subchapter S of Chapter 1 of the Internal Revenue Code.

S Corp Benefits

An S Corp combines the limited liability benefits of a corporation with the pass-thru taxation status traditionally afforded to partnerships. Also, the IRS allows an S Corp owner who works for the business to cap payroll taxes at the owner’s salary level rather than imposing the self-employment tax on all income under the self-employment tax threshold ($102,000 in 2008).

S Corp Taxation

An S Corp is not taxed at the business level as a C Corporation would be (double taxation). Rather, the profit or loss passes through the business to the owners and is taxed as income to the owners. The IRS provides information regarding the appropriate tax forms for S Corps.

S Corp Disadvantages

There are a few disadvantages to an S Corp:

• An S Corp must file quarterly estimated payroll taxes.
• An S Corp must maintain some corporate formalities to keep its limited liability protection.
• Unlike a sole proprietorship or partnership, an S Corp is created by filing with the Secretary of State.

Minnesota S Corp Formation

A Minnesota S Corp is formed by drafting Articles of Incorporation, Bylaws, and related formation documents and filing them with the Minnesota Office of the Secretary of State. Next, the business registers with the IRS to obtain an EIN and registers with other appropriate agencies (for example, the Minnesota Department of Revenue if the business will charge sales tax) as required by law.

Minnesota S Corp Business Attorney

Attorney Aaron Hall has formed countless small businesses, advised them on tax matters, litigated business disputes, and drafted complex business contracts.

Video Transcript

I’m starting a business. Should I do a sole proprietorship, LLC, or S Corp? As a business attorney, I get asked this question all the time. Often it’s by people who are starting a business for their first time. Often they have limited financial resources, and they’re trying to just get pointed in the right direction. So I’m providing this educational video to give you the general framework to make that decision.

First off, a sole proprietor: that’s going to be the easiest. There’s no registration required, there’s no filing fee, that you can get all the tax breaks of a single owner LLC. The one thing you don’t have is what’s called limited liability. As you know, an LLC is called a limited liability company. You don’t get that limited liability. But frankly, a lot of times you don’t care, and here’s why.

Here’s how limited liability works. If you start a business and you accidentally hurt somebody, you’re liable as the individual who hurt them, and then your business is also liable. So limited liability doesn’t protect you here. An LLC provides no protection in that scenario. Well, what if you have a contract on behalf of your LLC and the LLC breaches the contract? Well, in that case you’ll have limited liability. In other words, you won’t personally be liable. The LLC will, but you won’t personally.

Here’s the problem though. Most of the time with big contracts that might result in a breach, like maybe you’re gonna rent some office space, or you want to loan some, borrow some money from the bank, in those cases you’re going to be asked to sign a personal guarantee that makes you personally responsible even if you have a limited liability company. So you can see here, limited liability is important, but it’s not as important when it’s a single individual working in a business. It’s more important when you have employees or contractors, because an LLC or a corporation, both of them equally limit liability to the business entity when we’re talking about the improper acts of employees or independent contractors.

So again, if you’re an individual working in a business, sole proprietor might be a great option, if you don’t need that limited liability. Now, of course, you should always talk with an attorney, but this is general educational information to help you spot issues and have a better understanding of how the law works in this regard.

All right, so let’s say that a sole proprietorship is of interest to you. Do you have to do anything? No. You just start working on your business. Keep track of all expenses and income related to the business. You will be reporting that on Schedule C of your tax return. All business expenses that would be deductible in an LLC are also deductible here in your sole proprietorship. So no tax benefits.

What about an S corp? Well, there is an important tax benefit available in an S corp, which might cause you to lean in that direction, and here’s the idea. In order to understand it, you need to understand how self-employment tax works, also known as payroll tax, depending on the setting. When you work for an employer, you know how FICA, Medicare, Medicaid, and all those withholdings come out of your payroll check? Well, that is a payroll tax. The employee pays about 7.8%, the employer pays about 7.8%. It’s about 15% in total.

Well, think about it: when you’re working for yourself, you pay as the employer, and you pay that as the employee. So in the setting where you’re paying yourself, we call it self-employment tax. In the setting where you’re paying an employee, we call it a payroll tax. Either way, it’s essentially the same thing, the same percentage.

So why does this matter? Because in an S Corp you pay yourself a reasonable fair market wage. So whatever you’d have to pay for an employee, let’s say you’d pay that employee $40,000 per year. Let’s say the business brings in a hundred thousand. So you take home forty thousand as the employee and sixty thousand as the owner. Well, in that case you’re going to pay income tax on all of it, but you’ll also pay self-employment tax on the forty thousand that is your wage as an employee.

Now we’re talking in S corp. The amazing thing with an S corp is you’re not paying that employment tax or self-employment tax on the sixty thousand that you take home as an owner. In an LLC you do. In a sole proprietorship you do. So that’s an important benefit available with an S corp, a strong tax reason if your financials justify actually having to pay out that in an LLC or sole proprietorship.

So as you can see, there are a few different considerations here. First, do you need limited liability? And then second, do you have enough profit after paying yourself a reasonable wage where it would make sense to do an S corp and save that 15% employment tax on the profit portion of the money that you take home? A CPA can help you with this. A business attorney can help you with this.

And if you have questions, you’re welcome to drop them in the questions below. You can also go on to the Facebook group that I have and ask questions there, or search; maybe your question has already been asked and I’ve addressed it. This was Aaron Hall. I look forward to more videos like this with you in the future.