Two weeks ago in part one, we discussed the first two of four leading factors to consider when selecting your entity, and here, we cover the final two.
3. Taxation
Your entity selection dictates how your business will be taxed. If your business entity is a sole proprietorship or a partnership, you and the other owners are legally the same as your business, so your share of the company’s profits or losses are reported on your income tax return and taxed at your personal income tax rate.
In contrast, as a C corporation, your business is considered a separate legal entity from you and the other owners for both liability and taxation purposes. As a result, the corporation pays taxes at the current corporate tax rate. Then, after-tax profits are distributed to the shareholders. Those profits are taxed at the personal rate of each of the shareholders. This rate, “double taxation,” means the corporation pays tax at its rate, and then the shareholders pay tax at their rates.
As an LLC, you have flexibility in choosing how you’ll be taxed. Unless you choose to be taxed as a corporation, single-member LLCs are automatically taxed as sole proprietorships. In contrast, multi-member LLCs are taxed as partnerships. In such cases, your company doesn’t pay any taxes on its profits itself. Instead, your share of the net business income is taxed on your personal tax return, and you’ll pay taxes based on your personal income tax rate.
Alternatively, you can also elect for your LLC to be taxed as an S corporation. In this case, you’ll be responsible for paying payroll, plus payroll taxes, and filing a tax return on behalf of the corporation.
The main advantage of choosing to be taxed as an S corporation is that you only pay payroll taxes on your payroll, not on your profit distributions from the company. In addition, there is some indication that the audit risk for S corporations is less than the audit risk for companies taxed as sole proprietors, where income and expenses are reported on your personal Schedule C.
Suppose your business is taxed as an S corporation. You’ll pay income taxes on your profit distributions. Still, you would save roughly 15% in payroll taxes on distributions taken as profits rather than as payroll. When using an LLC taxed as a partnership or sole proprietorship, you’ll pay payroll taxes on all distributions to you from the LLC up to the payroll tax limits.
However, for an S corporation election to make sense, you’ll want to have at least $75,000 of net income per year. To help you choose the entity that’s most advantageous in terms of taxation, meet with us or a Certified Public Accountant (CPA).
4. Administration & Operation
If you start a new business and are the only owner, you’re automatically a sole proprietorship in the eyes of the law, or a partnership, if you have more than one owner. There’s no need to register your business with the state in either case, file any paperwork, pay any fees, and there are no special rules to follow.
While LLCs and corporations offer liability protection and tax advantages, those benefits come with specific administrative requirements known as corporate formalities. These formalities dictate how the entity must be structured, maintained, and managed. Suppose you fail to adhere to these formalities. In that case, a court could remove the protective barrier shielding your personal assets, known as “piercing the veil,” leaving you personally liable to creditors in the event of a judgment.
Corporations come with the most strict and complex administrative formalities. You must file articles of incorporation with the state, hold a regular board of directors and shareholder meetings, create and enact corporate bylaws, and maintain detailed record-keeping requirements, such as keeping detailed meeting minutes. Additionally, you must also file annual reports with the state and pay yearly fees to maintain your corporate status.
LLCs also comes with administrative formalities, but they aren’t nearly as burdensome as those for corporations. For example, as the owner of an LLC, you must file articles of organization with the state and create an operating agreement, which governs how your LLC is structured and run. In addition, all states require LLCs to file either an annual or semi-annual report with the state agency responsible for registering business organizations.
Although there’s no statutory requirement for LLCs to hold owner meetings or keep minutes, doing so provides strong evidence that you’re abiding by corporate formalities. Combining diligent record-keeping and clear separation of personal and business finances, you can offer your LLC extra protection from creditors.
Should you choose to set up as an LLC or corporation, we can offer support with maintaining your business records and the corporate formalities required. We offer exceptional maintenance packages to help ensure your entity meets these requirements and maintains the maximum level of protection for your assets.
Enlist Our Guidance and Support
Properly selecting, setting up, and maintaining your business entity is far too important of a task for you to try to handle all on your own. We offer you trusted advice on the most advantageous entity for your particular business and then help ensure that your entity is properly set up. We can also provide you with sound business systems to make your business more efficient and establish a clear separation between your business and personal finances, which is a crucial part of maintaining your entity’s liability protection.
In addition, we’ll also ensure that you comply with the various state laws and administrative formalities required to maintain your entity and safeguard your assets, so you can remain focused on the most important task—growing your business. Contact us today to get started.
AB Law, PLLC is a full-service business law and estate planning firm that serves clients throughout Texas. All consultations are free and no question is too silly, ridiculous, or complex. https://calendly.com/ablawpllc www.ab-firm.com