Going from S-Corp to Sole Proprietor

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Post Reply
Topic Author
RenoJay
Posts: 748
Joined: Tue Nov 17, 2009 11:20 am
Location: Nevada

Going from S-Corp to Sole Proprietor

Post by RenoJay »

I will follow up with my CPA on these questions, but first I was hoping to tap some Boglehead wisdom. For ten years I’ve owned an S-Corp. In the old days, I had lots of revenue from websites running through it, but lately it’s mostly a vehicle for commission income I earn from doing sales. I learned the hard way that having a S-Corp does NOT protect one from personal lawsuits, and at this point, I can’t figure out the purpose of maintaining my S-Corp since I end up paying about $2,500/year in various fees, expenses, taxes, etc. to maintain it. So I’m considering becoming a sole-proprietor to save on expenses and hassles. Here are some questions I’m wondering about and will be grateful to anyone who has insight on any of them:

As a sole proprietor:

1. Will I be required to pay myself a W2 wage as I am currently as the owner of an S-Corp? (i.e. do I need to keep my payroll company?)

2. Currently my SEP IRA contribution is limited to 25% of the W2 wage I draw from my S-Corp. Does this restriction get lifted if I’m a sole proprietor? (i.e. will I be able to contribute up to 50% of TOTAL INCOME as opposed to W2 income, subject to max contribution levels.)

3. Are there better retirement plan options for sole proprietors?

4. How does social security tax work as a sole proprietor? Is it due on ALL income up to $117k?

5. I presume I’ll still be paying the self-employed rate on social security of 15.3%, right?

6. Will I still get to deduct normal business expenses?

7. Are sole props required to make quarterly estimated tax payments?

8. Currently my CPA permits a full write off of my family’s health insurance premiums. Will this continue as a sole prop?

9. Aside from the liability/protection argument (which I’ve already discounted because it really doesn’t exist), is there any reason NOT to become a sole proprietor?

Thanks in advance!
User avatar
Raybo
Posts: 1976
Joined: Tue Feb 20, 2007 11:02 am
Location: San Francisco
Contact:

Re: Going from S-Corp to Sole Proprietor

Post by Raybo »

It's been a long time since I thought about this. But, I went from a C Corp to Sole Proprietorship (SP) many years ago (think Reagan Tax "cuts").
RenoJay wrote: As a sole proprietor:

1. Will I be required to pay myself a W2 wage as I am currently as the owner of an S-Corp? (i.e. do I need to keep my payroll company?)
No. As a SP, you take what you want out of the company. You will file a 1040 Schedule C and your taxable income will be the profit listed on that form, whether you take out more, less, or none at all. You won't get a W2 so get rid of the payroll company.
2. Currently my SEP IRA contribution is limited to 25% of the W2 wage I draw from my S-Corp. Does this restriction get lifted if I’m a sole proprietor? (i.e. will I be able to contribute up to 50% of TOTAL INCOME as opposed to W2 income, subject to max contribution levels.)
This is a tax question best answered by someone knowledgeable about current retirement plan options. In my (out of date) experience, corporations have more flexibility than SPs whose options are usually some variation of IRAs.
3. Are there better retirement plan options for sole proprietors?
See above answer.
4. How does social security tax work as a sole proprietor? Is it due on ALL income up to $117k?
Social Security tax is based on the amount of income/profit you show on your Schedule C form. Note that you will get a deduction (pre-AGI) for half the SS tax you pay.
5. I presume I’ll still be paying the self-employed rate on social security of 15.3%, right?
Yes, but you do get a deduction for half of it, so No.
6. Will I still get to deduct normal business expenses?
Yes. Check out the 1040 Schedule C form to see how you will be reporting things from now on.
7. Are sole props required to make quarterly estimated tax payments?
Yes. However, they are based on your Schedule C income versus your wages. Since your income might vary quarter to quarter, you estimated tax payments can do so, as well. There is a form submitted with your taxes that breaks your income down into 4 quarters and allows you to compute the estimated taxes you have to pay. If your income is variable, your estimates taxes can be, as well.
8. Currently my CPA permits a full write off of my family’s health insurance premiums. Will this continue as a sole prop?
I believe so, but ask your CPA. Needless to say, the laws around health insurance have changed recently.
9. Aside from the liability/protection argument (which I’ve already discounted because it really doesn’t exist), is there any reason NOT to become a sole proprietor?
The main reasons I started as a corporation was a) unemployment insurance and b) better retirement plans (Defined contribution, defined benefit, etc). There may be other benefits of a corporation that I am not aware of. But, if it is only you doing the work and you don't feel the liability protection is there, than likely not.
No matter how long the hill, if you keep pedaling you'll eventually get up to the top.
Spirit Rider
Posts: 13977
Joined: Fri Mar 02, 2007 2:39 pm

Re: Going from S-Corp to Sole Proprietor

Post by Spirit Rider »

Ok, I will take a shot, but I am not a professional. So you will want to verify this. Note: It is not unknown that CPA's are sometimes ill-informed especially When it comes to retirement accounts.

1. No, you do not pay yourself as a W2. All net self-employment income in a sole proprietorship flows through to the owner.
2. No, for self-employment, the maximum profit sharing contribution is 20% of net self-employment income(business profit - 1/2 SE Tax). This is equivalent to the 25% of S-Corp W2 wages, because the contribution itself is coming out of the income.
3. Yes, a solo 401k allows you to make an employee deferral contribution (max $17.5K in 2014), plus the same profit sharing contribution as the SEP IRA, with a total maximum of $52K in 2014. Both of these increase by $5.5K if you are over 50.
4/5. A sole proprietor pays SE Tax (15.3%) using Schedule SE on their Business Profit from Schedule C. This is applied up to the SS max wage base ($117K in 2014). Medicare (2.9%) is not income limited and there is the new ACA surtax if your income is high enough. 1/2 of your SE Tax is available as a deduction.
6. Business expenses are deducted on Schedule C.
7. All tax payers are required to make quarterly estimated tax payments if their tax liability requirements are not met by exclusions, limitations, and or withholding from other income sources. As a practical matter, if your income is primarily from self-employment, you will need to make quarterly estimate tax payments.
8. A sole proprietorship is also entitled to the self-employed health insurance deduction.
9. I don't know what your unique circumstances were. Liability protection is never unlimited, that doesn't mean it doesn't provide some value. If you are moving to a sole proprietor model, you should still consider a single member LLC which defaults to what the IRS calls a "dis-regarded entity". That means your get the business entity model of your state, but for IRS purposes you are a sole proprietor filing a Schedule C. Then you should back this up with business liability insurance.
User avatar
White Coat Investor
Posts: 15157
Joined: Fri Mar 02, 2007 9:11 pm
Location: Greatest Snow On Earth

Re: Going from S-Corp to Sole Proprietor

Post by White Coat Investor »

RenoJay wrote:I will follow up with my CPA on these questions, but first I was hoping to tap some Boglehead wisdom. For ten years I’ve owned an S-Corp. In the old days, I had lots of revenue from websites running through it, but lately it’s mostly a vehicle for commission income I earn from doing sales. I learned the hard way that having a S-Corp does NOT protect one from personal lawsuits, and at this point, I can’t figure out the purpose of maintaining my S-Corp since I end up paying about $2,500/year in various fees, expenses, taxes, etc. to maintain it. So I’m considering becoming a sole-proprietor to save on expenses and hassles. Here are some questions I’m wondering about and will be grateful to anyone who has insight on any of them:

As a sole proprietor:

1. Will I be required to pay myself a W2 wage as I am currently as the owner of an S-Corp? (i.e. do I need to keep my payroll company?)

2. Currently my SEP IRA contribution is limited to 25% of the W2 wage I draw from my S-Corp. Does this restriction get lifted if I’m a sole proprietor? (i.e. will I be able to contribute up to 50% of TOTAL INCOME as opposed to W2 income, subject to max contribution levels.)

3. Are there better retirement plan options for sole proprietors?

4. How does social security tax work as a sole proprietor? Is it due on ALL income up to $117k?

5. I presume I’ll still be paying the self-employed rate on social security of 15.3%, right?

6. Will I still get to deduct normal business expenses?

7. Are sole props required to make quarterly estimated tax payments?

8. Currently my CPA permits a full write off of my family’s health insurance premiums. Will this continue as a sole prop?

9. Aside from the liability/protection argument (which I’ve already discounted because it really doesn’t exist), is there any reason NOT to become a sole proprietor?

Thanks in advance!
1. No
2. Uh, no, not 50%. It works out to 18-19% or so.
3. No, but you can contribute more sometimes since S Corp dividends can't be used to calculate maximum contributions.
4. Yes. Plus Medicare tax on everything you earn. This is the main benefit of incorporating- saving payroll taxes.
5. Yes.
6. Yes.
7. Yes.
8. Yes.
9. Payroll taxes.

I'd love to hear your story about how your S Corp didn't protect you from a personal lawsuit.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course
pshonore
Posts: 7079
Joined: Sun Jun 28, 2009 2:21 pm

Re: Going from S-Corp to Sole Proprietor

Post by pshonore »

One liitle glitch that you should be aware of. If you're using the S-Corp structure, you can avoid paying SE tax on the health insurance premiums. That same benefit does not apply to a sole proprieter. Of course if you're over the SS limit then only the Medicare piece is saved.
Topic Author
RenoJay
Posts: 748
Joined: Tue Nov 17, 2009 11:20 am
Location: Nevada

Re: Going from S-Corp to Sole Proprietor

Post by RenoJay »

Thank you all for the excellent feedback and advice!
Retired1809
Posts: 374
Joined: Fri Feb 23, 2007 4:11 pm
Location: North Carolina, USA

Re: Going from S-Corp to Sole Proprietor

Post by Retired1809 »

If you're comfortable with the unlimited personal liability characteristic of operating as a sole proprietor, I'll respond that reporting your business revenue and expenses on Schedule C of your 1040 is much simpler than corporate returns and payroll tax returns. If you're a one-person corporation, I always considered paying Unemployment Insurance premiums for myself a total rip-off because an owner can't qualify for unemployment benefits (despite paying required insurance premiums). Look at a Solo Roth 401k if you have no employees; they allow generous contributions to Roth IRAs as well as tax-deductible discretionary contributions ("d.c.") equal to 25% of income BEFORE the d.c. You put away some serious money - unless Congress acts to limit contributions. POTUSA is making noise about successful people putting able to put away "more than they need." Feeling my blood pressure rising...
SeattleCPA
Posts: 456
Joined: Fri Jul 06, 2012 7:06 pm

Re: Going from S-Corp to Sole Proprietor

Post by SeattleCPA »

So we work with a lot of S corporations in our CPA practice and I would say you're maybe operating under at least a couple of misconceptions and perhaps missing the big point...

First potential misconception: S corporations aren't a legal protection thing... they are tax things. Eligible entities (for the most part regular corporations and limited liability companies) can elect to use the accounting rules contained in Subchapter S of the Internal Revenue Code. So saying an S corp doesn't provide legal protection is, well, sort of nonsensical. What is debatable but would make more sense (if you want to talk about liability) is to say that a corporation or LLC doesn't protect you. But S corporation status has nothing to do with legal liability protection.. Zero.

Second potential misconception: You should probably consider (depending on state costs) the option of operating as a single member LLC and then accepting the default tax treatment... that would mean you do your taxes as if you're a sole proprietorship... but you get the legal protection of an LLC.

Note: We give away free copies of LLC formation kits for all fifty states... the kits include a little ebook and then boilerplate operating agreements... you might want to look at work of setting an LLC up in your state. Click here if you'd like one of these and so need the free download instructions.

The big point which you may possibly be missing (or maybe something you already know and so didn't need to go into here) is this: S corporations are all about the payroll tax savings. You need to pay yourself reasonable wages--and if you don't, IRS can reclassify distributions. But you should usually be able to avoid self-employment taxes on your health insurance, your pension matching, and a chunk of your profits.

BTW, I would think if your scaled back business makes four figure or low five figure profits that an S corporation doesn't justify the costs... but if you're in high five figures or six figures, you should be able to save five, ten grand... maybe more. BTW anyone who's making seven figures should probably be an S corporation given the ACA surtax. In that scenario, you're probably talking about tens of thousands of dollars in medicare tax savings.
Post Reply