How to Fortify Your S Corporation

Welcome to the Profitable Painter Podcast. The mission of this podcast is simple: to help you navigate the financial and tax aspects of starting, running, and scaling a professional painting business. From the brushes and ladders to the spreadsheets and balance sheets, we've got you covered. But before we dive in, a quick word of caution: while we strive to provide accurate and up-to-date financial and tax information, nothing you hear on this podcast should be considered as financial advice specifically for you or your business. We're here to share general knowledge and experiences, not to replace the tailored advice you get from a professional financial advisor or tax consultant. We strongly recommend you seeking individualized advice before making any significant financial decision.

This is Daniel, the founder of Bookkeeping for Painters.

This is Richard, tax director with Bookkeeping for Painters.

How's it going?

It's, it's good. We are in Yeah, I'm not sure when folks are listening to this, but when we're recording it, we are in the middle of a great upper Midwest winter. We've got like a foot and a half of snow on the ground and we're lucky to get above 0 degrees. So it's nice to be inside.

Yeah, I mean, I'm nowhere near that bad. Like, I'm in Orlando, Florida right now. And it's still annoying though. I'm used to Nicaragua where it's always 75, 80 degrees with a breeze and it's sunny. Right now in Orlando, it's like 60 and overcast. So I'm kind of upset about that.

But, but Florida's getting it right, because I heard, I heard from a colleague in the Panhandle that it was like below freezing there this week. That's kind of rare for Florida, isn't it?

Yeah, I guess at night it has gotten into the 40s. At least here, I'm probably definitely colder in other places. But yeah, it's— I don't have much to compare it to. I've only been in Florida a little bit. But yeah, it's, it's still not great weather, at least from my perspective. But I don't really have room to complain given what you just cold as hell.

Well, I don't think there's anything colder than dealing with the IRS. And I think today we're going to have some really interesting information for everyone who has a company. You know, we're going to focus mostly on S corps, but most of this also applies if we have an LLC that is being taxed, you know, as a disregarded entity. This is all about protecting your company and protecting that corporate veil. And that's that thing that's going to keep, you know, lawsuits from coming after your personal assets and it's going to keep you out of hot water with the IRS or with the state. So I'm kind of excited about this. I like top 10 lists. Today is top 7, but they're all very good points.

Yeah, I think a lot of, a lot of times this gets forgotten until, you know, something comes up and then like, oh shit, I gotta pay attention to this.

Right.

So it's good to be aware of these things. And a lot of this stuff is not hard to implement or make sure you're doing right. And just taking, you know, the time to listen to this podcast and then maybe an hour per year, you know, not much time to make sure this stuff is getting taken care of is well worth, well worth it.

Yeah. So should we just go ahead and jump in?

Sure.

Top 7 list of things to be aware of if you want to properly maintain your S corporation or LLC. And number 1 is your corporate documents. These are the pieces of paper that actually set up your company and that also maintain it throughout the year. So if you have an LLC, then you have filed articles of organization with your state, but you also need to have an operating agreement, especially, especially if you have more than one person involved with the business. So if you have partners or multiple shareholders, your operating agreement is going to dictate everything. It's going to say who does what in the company, who owns what, how does the money come out, who gets what. And it's going to be the document that you kind of live and die by. So that is probably one of the most important things when you are setting up your company. Other things that you might want to consider you know, bylaws, annual meeting notes. And we'll talk more about that later too. Anytime like a major decision is being made, you're going to want to document it. So if you are taking a salary and maybe you've got a salary recommendation, you want to adjust that, that's something that you're going to want to put in writing. You know, it doesn't have to be super formal, but we do want to have some kind of you know, some kind of record of it.

Yeah. And I would be— I'm sorry, go ahead.

I go ahead, Dan.

So one of the things that I come across a lot when I talk to folks about, you know, what type of entity they have, they often think that they're an S corp. Like, yeah, I had my accountant, he submitted some paperwork and I think we're taxed as an S corp now. But it turns out that didn't happen for whatever reason. Either the accountant never did it or got lost in the mail. They never got a form back from the IRS that says, hey, this LLC will now be taxed as an S corp moving forward. You know, they don't have a copy of their 2553 form to submit to the IRS. They don't have any of that. And so that's, that's a big thing that I— we come across a lot. It's like, are you actually even an S corp to begin with?

Yeah, if you have any doubt, you can call the IRS and you can ask. And I always recommend getting it in writing. So when you first do the S corp election, they're going to send you a letter in the mail. It says your S corp election has been approved as of such and such a date. Now they will only send that particular letter once. But if you call them and you say, hey, I just need confirmation, they will send you a different letter. It's not the same letterhead, but it will say the same things that, you know, on this date you conversed with IRS agent so-and-so and they confirmed that your S corp election for your company, EIN blah, blah, blah, is you know, January 1st, 2020. If we get new clients and they don't know if their S corp election was approved, that's the first thing I'm doing. I'm getting on the phone with the IRS and I'm getting proof. Because here's the funny thing about the IRS, you may be filing S corp tax returns every year and you may not have a valid S corp election and they're not going to say anything to you. Your returns will be accepted by the electronic filing system and they'll go into what I call IRS limbo, which I imagine is that one office in the basement that just has like mountains of paper on there and one very old—

returns.

Yes, yes. It's like the— that one old, like disgruntled IRS employee should have retired years ago, but He can't find his way out of the dungeon, but that's where they go. And they don't tell you until you find out, you know, years later, holy cow, I haven't filed an actual accepted tax return for years. So make sure you have your acceptance letter or at least some kind of a letter from the IRS saying that you have a valid S corp election.

Yeah.

Yeah.

So number 2 is keeping annual minutes and board meetings.

Yeah. So annual minutes. This is— I like to have a binder. I think every, every entity, every LLC should have a binder. Write your company name on the front. And in this binder is where you're going to keep notes of all the major decisions. We decide to hire a new sales manager. Awesome. Write it down. Date, salary, who made that decision? Put it in the binder. Those are going to be your annual minutes like we talked about earlier. Maybe you're changing an owner's salary. When you go to set up your board of directors or board of advisors, you're going to want to have that. In your binder. That's very important. And one of the reasons it is so important to have this board of advisors is this helps legitimize your LLC. So board of advisors, if you're an LLC, board of directors, if you're a corporation, this legitimizes the entity. This gives you asset protection. If somebody tries to sue your company and then come after you personally, Having this binder with these documented decisions and a board of advisors or board of directors is going to show a court that you are serious about operating this business as a separate entity. And it's going to add a lot of weight to the argument that, you know, someone who's suing should not be able to pierce that corporate veil and come through the company and go after you personally.

Yeah. And it's also can be, you know, keeping those board meetings, you know, you can put whoever you want on your board and it could be a good tax strategy to put, you know, your key, key friends and family associates on your board and then be able to write that off. We did a whole podcast on that previously.

Absolutely. I mean, we, we already have a group of people who we go to for advice. We just don't formalize it usually. And so a board of advisors does that. It just says, these are the folks who I trust to give me the, the advice and the feedback that I need. They're the ones who are going to shoot straight with me. And you write them down, you hold your meeting, maybe you do it at a restaurant or some other place where it is, you know, conducive for a board meeting. As long as it's ordinary and necessary, that's going to be a tax write-off. So formalize that step to get that counsel that you need to strengthen your corporate veil and enjoy a meal that you don't have to pay taxes on. That's kind of a little bonus.

Yeah. Yeah, absolutely. So number 3 is your annual state Secretary of State or your annual Secretary of State filings. So this is— these are the documents that you have to just update your Secretary of State that says, hey, I'm still an LLC and here's the owner of the business, here's how you can get a hold of us. And, you know, usually nothing's changed. Sometimes something has changed, maybe you moved or whatever, but basically the state wants you to submit a filing to them every every year to let them know what the status of your entity is.

Yeah. And there's one other thing they want too with that filing.

Some money.

That's cash. Yeah. Yeah. They got to get their money, man. Exactly. Uncle Sam doesn't do anything for free now. Yeah. And how much that renewal fee is is going to vary between state and state. Here in Illinois, we're actually pretty fortunate. It's $75 a year. If you live in California, it's going to be $800 a year minimum. So there's definitely certain states where it's less expensive to have your LLC than others, but make sure you file that report and pay that money because if you don't, then the state does an involuntary dissolution which is a fancy way of saying they canceled your LLC, and that is not good. You lose all your asset protection and you may have some other problems as well if the state dissolves your LLC. So make sure you get those filings in. And if you need like help with that, because like I admit, like, you know, I get busy business owners. You're not thinking about this little letter that came in in the mail. So there are companies that will handle this for you. Very, very reasonable. You know, we can recommend Main Street Business Services. They are a partner of ours who will help you with your annual state filings. They will also help with your beneficial ownership reports. That's part of the Corporate Transparency Act. and it's a very reasonable price, so they can take that off your plate if you want them to, or you're free to do it yourself. Just don't forget.

Yeah. All right. So that was number 3, right? So we're on number 4, which is regular operations and using the name.

Yeah. So if you have an LLC, you want to be using this LLC. So that means the LLC should have a bank account, not your personal account, one that's in the name of the LLC that you use. You run your business transactions through the LLC bank account. If you run them through your personal bank account, how are you going to argue that the business should be treated separately from you? That's, that's one of the easiest ways for a lawsuit to pierce that corporate veil. Another thing we want to think about is, is kind of like using the name. So if you have an LLC or an S corp and you are signing a document on behalf of the company, you're not going to necessarily sign your own name. You are going to sign, you know, ABC LLC, Richard Dunton, Managing member. So you are signing on behalf of the company because the company is a separate legal entity. And that is going— I mean, I mean, you know, especially for important documents, you know, state documents, contracts, things like that. Another thing we might think about, and this is especially important with S corps, and that has to do with what's called the assignment of income. So are your customers writing checks to you individually or are they writing checks to your corporation? If they're writing checks to you individually, the IRS could say that income has been assigned to you individually and now you need to pay taxes on it separate from your S corp. And now you're looking at self-employment tax and you're looking at problems. So if at all possible, have your clients, customers write their checks out to the name of the company, not you individually.

Mm-hmm. Yeah. So number 5 is quarterly payroll. So this is you writing checks to yourself through payroll. So this is definitely a hot topic for S corps because the IRS has this reasonable officer salary requirement. So when you start your— you have your LLC, you elect it to be taxed as an S corp. You may not have been running salary before, you know, for yourself. You maybe just take— took draws out of the company whenever you need money from the company to, you know, to live your life, that you would just take money out, write a check from the business to yourself, and you go. Now as an S-corp, you actually have to run this through payroll and pay payroll taxes on that. And the IRS has this reasonable officer salary requirement of paying yourself. So what are some things that we should look out for in this regard?

Yeah, so if you have an LLC and you're not doing an S-corp election, you can kind of sit this one out. But yeah, if you're, if you're an S corp, you got to get yourself on salary and it needs to be, I would say, a minimum of once per quarter. The reason I know some, some accountants will be like, well, let's just run it all at the end of the year. I don't really love that idea for a couple of reasons. One, payroll tax reports are filed every quarter, and if you pay yourself once a year, you're sending in a 000 and then boom, salary. It doesn't, it doesn't look great. Sometimes the states will freak out and they'll send you nasty letters. Sometimes if you don't run payroll, if you have a zero payroll for like 2 or 3 quarters consecutively, consecutively, sometimes the state will actually cancel your tax ID numbers. You don't want that either. And then two, you have to pay payroll taxes on these salaries, and it's kind of hard to come up with payroll taxes all at once. Much easier if you spread them out over 4 quarters. So pay yourself once per quarter and try to dial your salary in as tight as possible. You have to be paid reasonable compensation, but I don't want you to pay yourself any more then you have to, because obviously paying yourself through payroll means payroll taxes. So come up to that line, but go no further so that you're not overpaying in payroll taxes. And that's one of the reasons why I always do an annual reasonable compensation report with my tax planning clients. Things change every year. Let's make sure that their salaries are really dialed in as tight as possible. So that they're getting the protection they need but not overpaying.

Yeah, absolutely. And I would, I would say if you haven't been paying yourself quarterly and it's the very end of the year, go ahead and run that at least one payroll. Yes. Before the end of the year, just so you can get that reasonable salary in, you know, right before the, you know, clock strikes 12 on December 31st. So you don't get in trouble for not running an officer salary.

Yeah. And, and just as kind of a, you know, a warning, this is extreme. So not paying yourself salary, if you look at the, if you look at the S corp tax return, line number 7 is officer salary, officer compensation. You're reporting to the IRS how how much you paid yourself in salary. There's another line on there that shows— it's line 16F on Schedule K— that shows distributions. So it is extremely easy for the IRS to know, one, did you pay yourself reasonable salary, and two, did you take distributions? And they are cracking down on this because it is such low-hanging fruit for them. So make sure that you have something on line 7, especially if you're taking distributions.

Yeah. And usually, you know, the S corp is audited less. You know, usually the IRS is going after sole proprietors more often for audits. But when it comes to an S, if you have an S corporation, you're not paying yourself a salary. That's really That's a, that's a big red flag. So yeah, take advantage of the S corp. Just make sure that you're abiding by that reasonable salary piece to stay out of, you know, having to deal with the IRS.

Absolutely. Number 6, we started talking about it already, but that, that is the tax return filing, right? So we all know we have to file a tax return. And if we have an S corp, we have to file an additional tax return. That is the 1120-S. And when you have an S corp, the IRS is a little bit stricter than they are with sole proprietorships and 1040. Now, it is true what Daniel mentioned, that S corps are audited about 15 times less frequently than the sole props. But on the other side, the IRS holds them to a higher standard. So your S corp tax return is due on March 15th. If you file an extension, you have until September 15th. Now that is a whole month sooner than your 1040 and your sole proprietor tax returns. If you are late with your S corp filing, the penalties are much higher. They are $210 per month per shareholder. So if you're the only shareholder, figure $210 a month. If you've got multiple shareholders, that can be thousands of dollars for every month you're late. So the moral of the story, don't be late with your S corp tax return. Plus you have to have that one filed before you can file your 1040 anyway. So if you're late with your S corp, it's just going to kind of compound.

All right. The number 7, the last one is the state tax filing requirements. So, you know, number 6 was filing your tax return on time. But, you know, we always think of the federal side of things, your 1120-S, your federal tax return. But most likely you're going to have to file a state tax return with that. An S corporation state tax return.

Yes. And some states have taxes, franchise taxes, sometimes they're called excise tax. I think of them as a privilege of doing business tax that the state hits you with. Here in Illinois, it's called the replacement tax, and it is 1.5% of your profit. So you're not— you're usually not paying any taxes on your federal 1120-S that's getting passed through to your 1042 return. But your state 1120-S or whatever your state's equivalent is, sometimes they don't use the same numbering system that may have taxes due. Like I said, Illinois, it's 1.5%. California definitely has one. I know even, even so, like Texas, generally a tax-free state, but under certain circumstances, if you're doing commercial work, you might owe a check to the Texas Comptroller. So know what your state's tax requirements and filing requirements are. Another, another time you might need to pay is if you're doing pass-through entity tax, which is an awesome tax saving strategy. but it does require a payment or at least a reconciliation when you file your state 1120-S.

Yeah, and we did a whole podcast on the PTET, pass-through entity tax, tax strategy. So search through the archives on that one. That's a good strategy to save thousands of dollars per year. So in most states at this point have that. So that's a good one.

Yeah. One other thing to mention about that, and this, this goes back to when you're first doing your S corp election. We talked about the Form 2553 that gets sent to the IRS. We make sure we get that approved. Most states say, well, if the IRS approves it, we approve it. Not all, though. New Jersey is a big one. New Jersey requires its own separate S corp election, and there are some other states that do as well. So I have heard horror stories, not, not any of our clients, but I have heard from other accountants. Yeah, we did the federal election. Everything was great. We filed it for 3 years. Then all of a sudden the state of New Jersey says, hey, you've never had a valid election with us, and now you've got a huge mess you have to untangle on the state side. So just every state is different. Try to make sure that you are abiding by your state's particular quirks and rules and things like that.

Well, all right. So bottom line, S corp is a great tax status that you can use to save big on taxes. Just need to make sure you're following the rules. There's a little bit more rules you got to follow. But it's— it can be well worth it. And you can save thousands, if not tens of thousands per year using this S corp tax status.

Absolutely. But, you know, it's just like owning a vehicle. It's great when we get it, but if we fail to maintain it, it, you know, a blessing turns into a curse. So a few simple rules to keep your S corp in good working order. Think of it kind of like a little tune-up for your S corp. And if something bad was to happen, like a lawsuit, knowing that your LLC/S corp is, you know, rock solid is going to help you sleep at night and it's going to give you that protection that you're looking for.

Yeah. Yeah. So if you're, if you're listening right now and you're not an S corp, not taxed as an S corp, and you're doing more than $50,000, $60,000 in profit, definitely look into this tax status to see how you can take advantage. I just talked to somebody a couple of days ago. They're doing like $100,000 in net profit and they're still a sole proprietor in a state that it would be completely— make complete sense to switch to being taxed as an S corp. But they're still on the sole proprietor. So don't— so they're overpaying. I think it was about $20,000 in taxes, if I'm remembering correctly. It was a good chunk of change. So don't let that be you. Make sure you take advantage of it. Just make sure you follow the rules with the S corp. But with that, we'll go ahead and wrap things up. Love to hear your thoughts on how to maintain your S corp. If you have any thoughts on doing that, or if you have questions about starting one or maintaining an S corp, let us know. Go to Facebook, type in Grow Your Painting Business and join the group there. And we'd love to hear your thoughts. With that, we'll see you next week.

Yeah, thanks for listening, everybody.