LLC

The LLC Trap

Operating a business as a limited liability company, or “LLC” is very popular among small business owners. LLC’s have been around for several decades and can be formed in every state. There can be several benefits, but several major drawbacks.

The Benefits of an LLC:

Less Administrative Burden: If you operate as a single-member LLC, you generally do not have to file a separate tax return. You also may not need to have worker’s compensation insurance, which can save on expenses.

Liability Protection: By having your business operate as an LLC, you will separate your business liabilities from your personal assets, which can offer protection of your personal assets.

Now, for the Drawbacks:

No Tax Withholdings: Since you usually do not draw a paycheck as an LLC member, you will not have taxes withheld from a steady paycheck. This requires you to remit estimated taxes quarterly, but in reality, many business owners miss some payments, make partial payments, or skip them altogether. This is how tax problems develop.

High Potential Audit Risk: Many LLC’s only have one owner and do not have to file a separate income tax return for the LLC. Rather, the activities from the LLC are reflected on Schedule C of their individual tax return. This is easier than having to file a corporate return, but at the same time, it increases your chances of being audited significantly.

Self-Employment Tax Shock: Since you usually have to pay self-employment tax as an active member of an LLC, this can double the amount of social security and medicare taxes because you have to pay both the employee and employer portion.

You need to carefully structure the way you operate your LLC in a manner so that you can reap the benefits, while at the same time reduce any downside. This should be performed with the assistance of a tax advisor that is well-versed in business structures.

Business Structure Issues – Key Differences Between an LLC, S-Corp, C-Corp and Sole Proprietor

Business owners have several choices of how they can operate a business. The decision should be well thought out and be able to meet their objectives. Here are some of the pros and cons of each structure:

Sole Proprietor: The easiest form of operating your business is as a sole proprietor. A sole proprietor has a much lighter administrative burden because you account for your business activity on your individual tax return. You may not need to file quarterly payroll tax returns, and may not need worker’s comp insurance. The downside to operating as a sole proprietor is unlimited legal liability, high self-employment taxes, and a much, much greater potential to be audited by the IRS than other taxpayers.

Limited Liability Company: A limited liability company, usually referred to as an LLC, offers greater legal protection than a sole proprietor, and is also extremely flexible. Depending upon various factors and elections, an LLC may be taxed as a sole proprietor, partnership, C-corporation, or S-corporation. In practice, we usually see single-member LLC’s that are taxed as sole proprietors, which means that they have the same downsides as well.

C-Corporation: A C-corporation offers legal protection like an LLC. The drawback is that you have to abide by more legal formalities, including paying yourself reasonable wages, hold annual meetings and take minutes, and also pay additional corporate taxes.  When you want to distribute the corporate’s profits, you will pay taxes yet again as they are considered dividends. C-corporations have their place, but are generally suitable for larger corporations.

S-Corporation: A variation of the C-corporation is the S-corporation. An S-corporation operates just like a C-corporation, but avoids the corporate level tax by taxing profits on the owner’s individual tax return, and has the potential to save employment taxes. The downside to an S-corporation is a higher administrative burden.

As you can see there are many pros and cons to each business structure and the decision should not be taken lightly. If you are thinking about choosing or changing your business structure, then you need to speak to a CPA or attorney who is very experienced with these matters.

Thinking of Starting a New Business?

Starting a new business can be an exciting endeavor. You get to be your own boss, create your own hours, and possibly achieve a greater sense of satisfaction. But what should you do to make sure your business is successful?

Proper planning goes a long way, and a business plan is an excellent starting point. A business plan should contain the following information (sample business plan can be seen at score.org):

General Company Description: What will your business do? What are your goals? What do you expect of the industry you will operate in? Will your business be structured as a sole-proprietor, partnership, corporation, or S-corporation?

Products and services offered: If you are a contractor, which type of construction will you perform – residential, commercial, or both? Will you be a general contractor or have a specialty such as plumbing? What are your competitive advantages and disadvantages?

Marketing: It is a good idea to perform some type of market research to make sure there is demand for your products or services. How will you obtain customers or clients? Will you serve a specific industry or niche?

Operations: What will the daily operations of your business look like? Generally, how will you run your business and manage employees.

Management and Advisors: Most likely you will be managing all aspects of your business during the beginning stages. You must realize though, that you cannot be an expert in everything. Advisors will help you to start off on the right track, save you time, money, and keep you out of trouble. A short list should include at a minimum: a CPA, attorney, insurance agent, banker, and a mentor. Never underestimate the value of a qualified professional advisor!

Start-up Expenses: You will need to estimate your expenses to start your business even before you begin operations. Some expenses can include legal fees, accounting fees, office equipment, software, machinery, vehicles, insurance, and marketing expenses. You need to know how you will pay for these expenses also. The funds may come from financing or personal funds used to capitalize the business.

Financial Plans & Projections: This should include a projected profit and loss statement for at least the first year, but it is also helpful to project the first 3 years, which is what I recommend. You want to make sure that when accounting for sales, the number is realistic and you can state how you will achieve this number. This also coincides with your marketing plan.

There is a lot to consider when starting a new business, but it is important to be thorough to insure its success. A little planning goes a long way to help your business start off on the right foot and avoid costly mistakes. Business planning is so important that it even makes sense for existing business to create a business plan to get back on track and take advantage of opportunities.

What is the Difference Between an LLC, S-Corp, C-Corp, and Sole Proprietor?

Business owners have several choices of how they can operate their business. The decision should be well thought out and be able to meet your objectives. Here are some of the pros and cons of each structure:

The easiest form of operating your business is as a sole proprietor. A sole proprietor has a lighter administrative burden because you account for your business activity on your individual tax return. Also, you may not need to file quarterly payroll tax returns, and may not need worker’s comp insurance. The downside to operating as a sole proprietor is unlimited legal liability, high self-employment taxes, and a greater potential to be audited by the IRS.

A limited liability company offers greater legal protection than a sole proprietor, and is also extremely flexible. You may have the option to be taxed as a sole proprietor, partnership, C-corporation, or S-corporation. Usually, single-member LLC’s are taxed as sole proprietors, which means that you have the potential to pay high self-employment taxes.

A C-corporation offers legal protection like an LLC. The drawback is that you have to abide by more legal formalities, and also pay corporate taxes.  Then, when you want to distribute the profits, you will pay taxes yet again as a dividend. C-corporations have their place, but are generally suitable for larger corporations.

A variation of the C-corporation is the S-corp. An S-corp operates just like a C-corporation, but avoids the corporate level tax by taxing profits on the owner’s individual tax return and potentially saves self-employment taxes. The downside to an S-corp is a higher administrative burden.

As you can see there are many pros and cons to each business structure and the decision should not be taken lightly. If you are thinking about choosing or changing your business structure, please call our office so we can advise you.