Many tax experts and business influencers are taking to social media to share knowledge of the S Corp tax election, which is a very effective way to save in taxes for growing, profitable businesses. if you haven't heard about this yet, make sure to listen to our 3-part series all about the S Corp here.
What most business owners do not hear, however, are the signs that you may not be ready for this just yet. Yes, it can save you thousands in taxes, but with great tax savings comes great responsibility. Let's dive into the top 3 things you need to do to prepare to elect the S Corp:
(1) You need to have rock solid bookkeeping.
We are not talking about a spreadsheet here. In order for you to make the most of your S election and remain compliant, we recommend you use a bookkeeping platform or hire this out professionally. You have outgrown the spreadsheet if you are thinking about the S Corp.
This also comes into play because as an S Corp, you need to pay yourself a reasonable salary as an employee (check Part 2 of our podcast series all about this). To know what to pay yourself, you will need on-demand insight into the performance of your business and what you are paying in payroll.
(2) You should be profitable at least $50,000 a year.
Why $50,000? Because that is roughly the point where the benefits outweigh the costs to implement an S Corp tax election. With these savings comes the fee to hire a payroll company, maybe a bookkeeper, and the costs of an additional tax return. All of these add up and can eclipse your tax savings if you are not maintaining a profit at that level.
(3) Your cash flow needs to be strong.
Cash flow is really the foundation of everything. In this case, you need to have a good enough cash flow that you are able to pay yourself a reasonable salary without a concern about bleeding your business bank account dry. You want to show that you can maintain a healthy inflow and outflow of cash that does not fall into extremes. This is driven by a solid recurring revenue source in your business.
Although the S election is a phenomenal tax strategy for business owners, it does come with a need for discipline and maturity. It's kind of like adopting a puppy - a lot of fun and benefits but you definitely need to give it the care it deserves.