Tax Tip Tuesday: Business Entity Structure Mistakes

Tax Tip Tuesday

New business owners get advice from all types of sources…Uncle Joe, the barber, the neighbor next door, or anyone that wants to share a story.  One of the post popular things that new business owners are told is that they need to set up an LLC because it will save them tons of money on their taxes.  And set the LLC up in Delaware or Wyoming.  Oh, and by the way, put it in the wife’s name, because there are all kinds of breaks out there for a woman owned business or a minority owned business. 

The new business owner jumps online and finds one of those services that will set up their business for a reasonable fee, but then they start adding on several other suggestions.

Then the new business owner comes to see me, and we have a different discussion.  Now every business can be different, and I don’t think there is a one size fits all structure.  But I do believe in keeping it simple.  So let’s pick this apart first. 

The Limited Liability Company

An LLC is a state created entity.  It stands for Limited Liability Company.  There can be some variations on the name based on the state. But it is a legal structure that is intended to do just what is says, give you some limited liability protection.  Now I will let the lawyers explain the liability protection to you, but it is limited.  It protects things that are part of the LLC.  So if you are looking to do rentals with an LLC, but you don’t title the property in the LLC name, it is not protected.

But here is the tax side of it.  There is no federal income tax form for an LLC.  No tax benefit for an LLC.  IRS considers an LLC as a disregarded entity.  They have very little instructions for an LLC other than to tell you that a Single Member LLC (SMLLC) is taxed as a sole proprietorship.  That means you file a Schedule C as part of your 1040 return.  If it is a multimember LLC (MMLLC), meaning there is more than one owner, then the partnership files tax form 1065. This is even true if the two members are husband and wife.  So, there is no tax savings. 

By the way, creating an LLC does not allow you to put yourself on payroll.  That is only possible if you are taxed as a corporation. Now, because an LLC is a disregarded entity, it can file with IRS to be treated as either an S corporation or a C corporation. Determining when this is a good idea will be based on the profit of the business.  I suggest that you start looking at this when the business profit is at about $70,000. 

The idea of setting up the LLC in Delaware or Wyoming is again a legal issue regarding how you can handle different litigation or other rules you must follow.  For example, most credit card companies are set up in DE, because they can follow the DE rules regarding interest rates they can charge. For taxes, you will pay taxes to federal no matter what, and you will be required to file a return in every state that you do business.

As far as the advantages of being a woman or minority owned entity, there is not tax advantage.  Everyone pays the same and has the same tax credits available.  The benefit is that on a government contract, a certain amount of the work must be allocated to disadvantaged businesses.  So, structuring as a woman or minority owned entity might provide you with a competitive advantage when bidding on certain jobs.  But look at what type of business you will be doing.  Does your business have the opportunity to be connected to any types of government jobs?  This is a possibility if you are in some type of construction or skilled trade.  My tax and accounting business does not have the opportunity for any type of government contract.  This would be true for a real estate agent, a restaurant, an art studio, and the list would go on.

Some states, like Maryland, require an LLC to file some type of annual return or report to “stay in good standing” with the state.  Typically, there is a fee assessed to maintain that “good standing” status.  For Maryland businesses, that fee is $300 every year.

Don’t get me wrong, sometimes an LLC is an excellent idea, but not always. Before you start a business, you need to consult with someone like me to help you consider the best way to structure your business entity.  While Uncle Joe may give you some food for thought, it is best to conduct due diligence from a team of professionals so that your business launches with the right entity structuring. 

My company offers a variety of business services.  Click for more information: https://saunderstax.com/bizservices.php or if you have any other questions, contact my office at 301-714-2071 or visit www.saunderstax.com.  We love helping you discover a Less Taxing Life and More Prosperous Solutions!

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