Daniel Cullinane CPA
25 Plaza 5 25th fl Jersey City NJ phone 732-516-1648 fax 732-516-9778
2500 Plaza 5 25th fl Jersey City NJ 07311 phone 732-516-1648 fax 732-516-9778
Copyright © Daniel Cullinane CPA.
Your business entity can be the most valuable player in your effort to protect your self and minimize taxes. The following issues could have a major impact on your entity decision.
The amount of your earnings and deductions
Tax planning to avoid paying too much self employment tax
Liability exposure from your product, services or location
Whether you have a partner or investor in the business
Business goals and marketing plans
The administrative costs and demands of setting up certain entities
To help you choose the one that is right for you. let us take a look at the four top options
A sole proprietorship is the simplest form of doing business. All you need to do is just start selling your product or service. No tax id number (EIN) is required. No doing business as (DBA) registration is required, although one is recommended for marketing purposes. No business bank account is required, although one is recommended for bookkeeping and audit protection. No extra tax return is required. All your income and expenses are reported on your 1040 form Schedule C.
One of the primary disadvantages of a sole proprietorship is the self employment tax of 15.3% on the ordinary net income generated by your business. Ordinary income include items such as sales of products or services, commissions or short term income in real estate if you are a real estate professional. SE tax does not apply to passive income such as rent, dividends, interest or capital gain.
Another disadvantage of the sole proprietorship is the owner's personal responsibility for the liabilities of the business. If you have a partner or investor in your business, it is almost a given that you form an entity rather than operate as a sole proprietorship. Simply by definition having a partner means you need to file a partnership tax return, will be taxes as a partnership, and have personal vicarious liability exposure for your partner's actions.
LIMITED LIABILITY CORPORATION (LLC)
An LLC is a fantastic entity for certain reasons, but it can also have some major drawbacks. Some of the benefits are
Personal protection from the operations of the business ( lawsuits )
The ability to reserve a business name and create a formal brand
Documentation of the relationship in a partnership via the LLC operating agreement
An LLC may suprise some business owners An LLC does not save on taxes in any way
There is a 15.3% self employment tax Many states have high fees to register an LLC
There are three primary reasons why an LLC might make sense in certain situations for a new business owner
Liability protection with rental property
Liability protection in an operational business and ability to convert to an S Corp later
Advantageous for partnerships An LLC is excellant for partnerships. It protects each partner from the actions of the other partner and allows for more efficient tax planning
Most small business owners with operational businesses should at some point consider organizing their ventures as an S Corp. Firt shareholders and officers of an S Corp are not personally liable for corporate debts and liabilities. Second your share of the S Corp's
corporate debts and liabilities. Second, your share of the S Corp's net income will not be subject to self employment tax. (15.3%)
Many small business owners establish an S Corp to start the process of building business credit. When you create an S Corp you will obtain a Tax ID number and eventually be able to establish credit and borrow funds solely in your company name. It takes time, but when done properly, it can be a hugh asset to a small business owner and is a notable ancillary benefit to operating an S Corp
S Corps are designed for small businesses, this election restricts companies to no more than 100 shareholders. The big benefit is that the S Corp is not subject to a corporate tax.. Net income after all business expenses are deducted flows through to the shareholders of the S Corp and their personal 1040 tax return on form K-1
Almost every Fortune 500 company is set up as a C Corp and they have specific reasons for doing so, such as raising capital and abiding by securities laws in order to go public. But for the average small business owner or startup this is completely unnecessary. Large corporations have different goals from small business owners, the least of which is saving money on taxes. A small business owner's needs are very different and mot of the time they can skip the complications of corporate double taxation and just use and LLC or S Corp
BUSINESS STRUCTURES FOR SMALL BUSINESS
Limited Liability Company
Which structure has the lowest tax rate?
S Corp the tax savings are very significant ( see example )
Which structure does the IRS audit the most?
Limited Liability Company
Example of the tax savings
Assume a single tax payer with an income of $100,000 S- corp a $5,000 salary and $95,000 in dividends
Sole Proprietorship LLC S- corp
Income tax $28,000 $28,000 0
Payroll Tax $15,000 $15,000 $750
Dividend Tax $12,750
Total Tax $ 43,000 $43,000 $13,500
The S-Corp results in a annual tax savings of $29,500
This is how it works. With an S-Corp a tax payer can divide earnings between salary and dividend. For this client the salary was set at $5,000 and the remainder a dividend. The big saving is the salary was taxed at 28% while the dividend tax rate is 15%. There is significant savings on the payroll tax due to the lower payroll.
A frequently asked question by LLC owners is the liability protection the same if I become an S-Corp, the answer is yes.
The IRS Selection for business audits is as follows Tax returns prepared by known disreputable tax preparers (who prepares your taxes is important) then Sole Priorprietors, followed by LLC followed by Corporations with over $10,000,000 in come thenS-Corp What the IRS is looking for in Audit Selection is what is there best chance of finding disallowable deductions. Sole proprietorship returns are usually prepared by individuals or nonprofessional tax preparers and a high percentage take tax deductions that are not allowable. The same is basically true for LLC tax returns but a lower percentage are selected than soleproprietorships as more tax professionals are involved. Most S-Corp returns are prepared by tax professionals and have less unallowable deductions. Also the IRS does not like dealing with tax professionals who know what they are doing. So this is another advantage of being as S-Corp There are other tax advantages such as the ability to take significantly higher retirement deductions such as $6,500 versus $52,000
CHOOSING THE RIGHT BUSINESS ENTITY