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What are the benefits of converting a sole proprietorship into an S corporation?
There are many benefits of converting a sole proprietorship into an S corporation. Generally the most common benefits are limited liability, reduction of self-employment tax, and no double tax on profits.
An S corporation provides some limited liability to its shareholders so that although creditors may come after the corporation, they cannot come after the shareholders individually. This means that the shareholders¹ personal assets such as their cars and houses are generally not at risk. Another benefit is the reduction of self-employment tax. This benefit is available only to an S corporation since distributions are free of self- employment tax. Only wages are subject to self-employment tax.
Finally, the S corporation only has a single level of taxation. This is in contrast to a C corporation that has two levels of taxation. The first level is a tax on the corporate level profits. The second tax occurs when the corporation then pays a salary to the owners, and they have to pay tax on that money. In an S corporation, there is generally no corporate level tax and, therefore, only a single level of taxation.
To become an S corporation, you can have no more than 75 shareholders, and you must file Form 2553 with the Internal Revenue Service.
Jeff Heimler is principal of Heimler & Associates, CPA. He can be reached at (949) 252-8192(949) 252-8192.
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