Questions to ask before changing your entity structure

Moving from a sole proprietorship to an LLC, or from an LLC to an S corporation, is often pitched as a way to save on taxes. Sometimes it does. It also adds payroll, filings, and paperwork. Before you change anything, work through these questions.

1. How much does the business actually earn?

The savings from an S corporation usually depend on profit being well above what you would pay yourself as salary. A business netting $40,000 a year rarely comes out ahead. One netting $150,000 might.

2. What would a reasonable salary be?

Owners who work in an S corporation must pay themselves a reasonable salary through payroll. The IRS looks at this closely, so the number should reflect what the work is worth, not what makes the tax savings look best.

3. What will it cost to run?

Add up a payroll service, an extra tax return, state filings, and the extra bookkeeping. If the savings are smaller than these costs, the change does not pay for itself.

4. What does your state charge?

Texas has no personal income tax, but most LLCs and corporations are subject to the franchise tax. Smaller businesses often owe nothing, though they still have to file. Other states work differently, so check yours.

5. Who else is affected?

Partners, lenders, landlords, and insurers may need to be told or may need to approve. Contracts and bank accounts often have to be updated.

6. Where do you want the business in three years?

Plans to add owners, sell the business, or buy property can change which structure makes sense.

What to do next

If you can answer most of these without guessing, you are ready for a real analysis of your numbers. If you cannot, that is a good place to start a conversation before you file anything.