As a business owner, knowing the best way to structure your company can help avoid personal liability and unnecessary taxes.
Forming an S Corp or limited liability company (LLC) are two viable options, each with different benefits and rules.
For pool and spa owners deciding whether to form an LLC, elect S Corp status, or pursue a combination of the two, here’s what each structure does, how they differ, and what industry veterans say you
should weigh before making the call.
Asset protection first
The most important consideration when deciding on a business structure is liability, professionals say.
“If you own a house, you’d better look at the structure of your company to find some sort of protection against any company debts so they can’t come after you personally,” says David Hawes, owner of
H&H Pool Services in Dublin, Calif.
Both LLCs and S Corps provide limited liability protection. The structures create a legal separation between the business and its owners. Since the business is its own entity, legally separate from the owner, creditors and plaintiffs with a claim can only go after business assets, not the owner’s house, car, savings, etc.
“I would absolutely bare minimum, be an LLC so you have the protection, so they can’t come after you personally, and don’t pierce the corporate veil,” Erik Taylor, owner of Chlorine King Pool Service LLC in Seminole, Fla.
What is an S Corp?
An S Corp is one option for structuring your business. According to the IRS, S corporations are those that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders report the income on their personal returns and pay taxes at individual rates. This way corporate income is only taxed once, instead of through both the company and the shareholder.
The IRS sets requirements that companies must meet in order to qualify as an S corporation. The business must be a domestic corporation, have no more than 100 shareholders, issue only one class of stock, and restrict ownership to individuals, certain trusts, and estates. Partnerships, corporations, and non-resident aliens cannot hold share. The election is made by filing Form 2553, signed by all shareholders.
An LLC explained
An LLC is a legal entity formed at the state level that combines the liability protection of a corporation with more flexible management and ownership rules. LLCs can have unlimited members, including foreign owners, and aren’t required to hold formal board meetings or document minutes.
It is different from an S Corp in a very fundamental way: “An LLC is a way to set up your business with the state,” says George Dimov, CPA and president of Dimov Tax, “and an S Corp is a way to file your taxes with the government.”
S Corp vs. an LLC
Both statuses offer protection against liability, but an S Corp is more structured when it comes to the organization and management of your business David Hawes, whose service company handles 900 pools a week and is organized as an S Corp, explains that either structure will offer the basic protection business owners would typically look for.
“S Corps and LLCs have many similar operating structures. It’s always a consideration for how you want to form them and what you’re trying to accomplish,” he says. “The S Corp has more formal
filing requirements with the state, and there are IRS considerations and so forth.”
For instance, even as a sole shareholder, Hawes still has to have a corporate board and hold board meetings to meet the requirements for an S Corp.
Another consideration for pool pros operating in a seasonal market is how owners are required to pay themselves. The IRS requires S Corp owners to take a reasonable and consistent salary for the work they do, so owners can’t wait out a lean winter and skip payroll the way an LLC owner could.
Dimov sees this play out every year with his pool industry clients. “ I have seen pool builders choose S Corp status in January, feel good about it, and then panic in December,” he says. “They set their salary high and did not have enough cash in the slow months.”
To work around this issue, he recommends carefully planning how you’ll pay yourself before filing. “The solution is to pick a salary that your slowest quarter can cover,” Dimov says. “Then you can add money when business picks up.”
Best of both worlds
One viable option for pool and spa pros is to form an LLC that is taxed as an S Corp. Taylor went this route years ago and now coaches other pool business owners on the structure.
“I’m an LLC, but I chose to be taxed as an S Corp, so I’m not an S corporation at its core, but I’m taxed as an S Corp,” Taylor says. He explains that when you’re forming an LLC, there’s a provision where you can choose to be taxed as an S Corp. “I get the tax benefits of an S corporation, but I’m an LLC at the end of the day.”
The benefit of the S corporation is that you avoid double taxation as an owner. A pure LLC owner could have dividends or draws taxed twice. S Corp status eliminates that second layer of taxation for
qualified distributions.
“With an S Corp, my wife and I can take a dividend or owner’s draw, and the company doesn’t get taxed on it. We only get taxed on it on the income side, so we avoid being double-taxed, and that’s the major benefit as an owner,” Taylor explains.
Being organized as an LLC means Taylor doesn’t have the stricter corporate formalities of a true S Corp. He doesn’t have to hold board meetings or keep corporate minutes and a binder full of documentation.
For small pool business owners who don’t want to commit to running a full corporate governance structure but still want the tax advantage, Taylor says it’s a happy medium. His advice in coaching
clients is straightforward: “I always recommend small pool businesses first, no matter what, form an LLC, and then I do recommend them to be taxed as an S Corp for the tax benefits.”
Dimov recommends this setup for businesses that are making at least $60,000 to $80,000 in profits. “You get to keep the things about an LLC, like being protected from lawsuits and having simple paperwork, and you also get the tax benefits of an S Corp,” he says. “This means you can split your income into a salary and other payments that are not subject to a 15.3% tax.”
Consider your revenue
The S Corp election isn’t automatically a win just because it’s available. Dimov, whose firm advises a range of service-industry small businesses, warns that the tax savings can disappear underneath the cost of running the structure itself.
Businesses with higher revenue stand to benefit more from S Corp status. Dimov’s example of what an S Corp is meant for is a business with a few vehicles and workers that makes over $200,000.
If you use the S Corp structure too soon, he explains, you can spend more money on things like payroll and tax returns than you save on taxes. Dimov recommends evaluating your income first. “If you are a service tech, retailer, or builder making over $70,000 after expenses, being an S Corp usually makes sense. If you make less, then the costs are too high.”
Start by consulting a pro
Hawes and Taylor recommend calling a CPA before you file anything. The choice between an LLC, an LLC taxed as an S Corp, and a traditional S Corp will depend on your business needs and goals. You’ll want to consider the state where you do business, your revenue, growth plans, business partners (including family members), and how you plan to pay yourself.
“The best advice I give everybody is to get with your CPA, who’s very familiar with how the taxation laws operate in the state as well as
federal,” says Hawes.
He draws a parallel that should resonate with anyone who has watched a homeowner try to balance their own pool chemistry. “The reason that we tell people they should hire us is because we’re professionals,” he says. “Let’s use the same argument for maybe an attorney or a CPA that we use for people to hire us.”
Pool pros who are still operating as sole proprietors are putting themselves at risk. The worst structure is no structure at all. Whatever you choose, Hawes urges, choose something.
