By Alfred Fricano
In the fourth and final part of this blog series, we’ll explore the benefits of organizing your new business by combining the features of an LLC and an S corporation.
There are certainly benefits of establishing your business as an LLC, but then electing to have it treated as an S corporation by the IRS for tax purposes.
To accomplish this, you'll have to make the special election with the IRS using Form 2553. It's no more difficult than setting up a corporation and then electing S corporation status. But it may have some added benefits, like:
Consider the pros and cons
Obviously, you need to carefully consider the pros and cons of different forms of business organization. Be sure to consider how all the aspects - legal, tax and operational - of each organizational form will impact your unique business enterprise.
Setting up an LLC and then electing treatment as an S corporation may just give you the best of both worlds - the ease of administration of the LLC and the tax planning opportunities of the S corporation.
Seeking professional advice from a CPA or tax attorney is always a wise practice when making choices like this that can affect your business for many years to come.
By Alfred Fricano
Congrats! You’ve started your own business. With any new venture there is usually mountains of paperwork and important business decisions that need to be made.
This four-part blog series is focused on one of those decisions: choosing to organize as an LLC, an S Corp or a combination of both. Each has its advantages and pitfalls. If you missed Part 1 and Part 2 you can read them here.
In Part 3, we discuss the pros and cons of operating as an S Corp, including what an S Corp is, its most important features and the benefits of being one.
What is an S Corp?
An S Corporation is a corporation formed by complying with state incorporation statutes that then elects (by submitting Form 2553 to the IRS) to pass corporate income, losses, deductions and credits through to its owners (shareholders) for federal tax purposes.
S corporation owners report the income and losses on their personal tax returns and are assessed tax at their individual income tax rates. Thus, S corporations avoid double taxation on the corporate income.
Limitations on S Corps
Certain limitations are placed on a corporation that seeks treatment as an S corporation. But if these limits don't interfere with your business plans, the S corporation may be a good choice for you. The main S corporation limitations include:
• It must be a U.S. corporation.
• It must have no more than 100 shareholders. However, all members of a family are counted as a single shareholder. Spouses are also counted as a single shareholder.
• Its shareholders can only be individuals, certain trusts, and estates - they may not be partnerships, corporations or non-resident aliens.
• It can have only one class of stock. But, it can have voting and non-voting stock within that single class of stock.
• Certain financial institutions, insurance companies, and domestic international sales corporations are ineligible.
Advantages of S Corps
A key benefit of the S corporation is its ability to minimize overall tax liability for you and your business. Because of its nature as a corporation, only the wages paid to its owner/employees are earned income that is subject to FICA tax (Social Security and Medicare).
Other net earnings that pass-through to the owners are considered dividend income. This means those payments not subject to SECA tax and — provided the shareholder material participates in the business — they are not considered passive income. Thus, an S corporation can do some tax planning that cannot be accomplished in a typical LLC.
How much should you pay yourself?
The ability to split income between compensation and dividends became even more important in 2013 when two new Medicare taxes were imposed on higher-income taxpayers. One was a 0.9 percent surtax on all compensation over $200,000 ($250,000 for married filing jointly).
The other was a new 3.8 percent tax on investment (passive) income if the taxpayer's modified adjusted gross income exceeds $200,000 ($250,000 for married filing jointly). Thus, the ability to split income can aid in reducing exposure to these new taxes.
Of course, the compensation that you pay yourself must be reasonable not too low or too high -if you want the arrangement to stand up to IRS scrutiny.
Reasonable compensation turns on many factors, but can be summed up by a "yes" answer to the question: "Is the compensation what would be expected for an individual with the background and qualifications in other companies of this size in this industry?
More features of S Corps
In summary, the most important features of the S corporation include:
• Limited liability for owners
• Pass-through of income to owners, avoiding double taxation
• The business exists independent and separate from the owner/shareholders
• Complex administrative operation - more forms and filings required, more formal meetings and record keeping requirements imposed (bylaws, meeting minutes, written resolutions, etc.)
• Profit-sharing restrictions - earnings distributed proportionate to capital contributions of shareholders
• Flexibility in distributing earnings of the corporation by paying wages and salaries to owner/employees and passing-through other net earnings as passive income to owners
Hire a professional accountant
When starting a business, deciding to organize as an S Corp or LLC can have a major impact on your tax responsibilities and liability. It’s not a decision to attempt to make on your own or take lightly. Seeking the counsel of a professional tax accountant can save you money and legal trouble down the road.
In Part 4 of this series, we’ll discuss the advantages and disadvantages of organizing in a way that takes the benefits of both an LLC and an S Corporation.
By Alfred Fricano
You’ve taken the leap and started your own business. You might already have a business name, a product line or list of services and office supplies. But before you put out the “Open” sign, you need to take care of one of the most important things: the paperwork.
Choosing to organize your enterprise as an LLC, an S Corp, or a combination of the two will have legal and tax implications. In Part 2 of this four-part blog series, we’ll look at the pros and cons of becoming an LLC.
LLC Offers Limited Liability and Flexibility
An LLC, or a Limited Liability Company, is a business structure authorized by state statutes. It is a structure designed to provide the limited liability features of a corporation along with the tax efficiencies and operational flexibility of a sole-proprietorship or a general partnership.
As a pass-through entity (unless it chooses tax treatment as a corporation), all of an LLC's profits and losses pass through the LLC to its owner(s), known as member(s). As with a proprietorship or partnership, each individual member reports the profits and losses on his or her federal tax return. This avoids the double taxation to which a regular corporation and its owners are subjected.
However, the LLC still provides a limit on the personal liability of its member(s) in much the same way a corporation does. Typically, a member's personal liability is limited to his or her investment in the LLC.
This feature distinguishes the LLC from a sole proprietorship or general partnership, in which each owner is subject to liability for all of the debts of the business.
Features of an LLC
The features of an LLC may make it an excellent choice of structure for your new business enterprise. The following summarizes the most significant features of the LLC:
Serves as a pass-through of income to owners, avoiding double taxation (unless corporate treatment is elected)
Ease of operation - fewer filings, forms, start-up costs, formal meetings and record keeping requirements
Fewer profit-sharing restrictions - earnings distributed as members see fit; not based on percentage of capital contributions
Entire net earnings of LLC passes through to owners in the form of self-employment income subject to 15.3 percent SECA tax (self-employment tax for Social Security and Medicare).
Tax Classification for LLCs
The IRS does not recognize the LLC as a taxpayer classification for federal tax purposes. Federal tax treatment is separate and distinct from the limited liability provided to members under state law. Whether an LLC is treated for federal tax purposes as a sole proprietorship, a partnership or a corporation, the members are still shielded from liability.
For tax purposes, by default, an LLC with one member is treated as a sole proprietorship. By default, LLCs with more than one member are treated as partnerships. However, an LLC can elect to be treated as an association taxable as a corporation by filing Form 8832, Entity Classification Election.
Once it has elected to be taxed as a corporation, an LLC can file a Form 2553, Election by a Small Business Corporation, to elect tax treatment as an S corporation.
If you’re starting a new business or are interested in more information about how your business can benefit from forming an LLC, contact our office.
In Part 3 of this series, we’ll discuss the advantages and disadvantages of organizing as an S Corporation.
By Alfred Fricano
So, you’re ready to leave the safety and security of your office cubicle and blaze a new trail into entrepreneurship? You have a wonderful vision for a unique new service or special product and are ready to start a small business – congratulations!
You need a business plan
Your passion and vision are a good starting point. Now what you need is a business plan. That’s where things can get complicated. You’re not just a freelancer – you’re a living, breathing business enterprise. How you choose to organize your business will have consequences - legal, liability and tax-related.
This blog will be the first in a four-part series that will help you determine which type of company your new venture should be. Specifically, you’ll learn about the differences between a Limited Liability Company (LLC) and an S Corporation. Each has benefits and shortcomings, which we will discuss. In some cases, your business could have the best of both worlds – we’ll explain how.
The goal of this blog series is to start the conversation by giving you a basic understanding of the options, and offer our assistance in helping you choose the one that’s best for your business.
LLC, S Corp or both?
Business owners, and even attorneys and accountants, can get bogged down in the debate over which is best - the LLC or the S corporation. But it's not necessarily an either/or proposition.
Rather, you can set up an LLC and later elect to have the LLC treated as an S corporation. If your LLC operates an active trade or business, and payroll taxes on the owner or owners are high, you may find that an S corporation is the best choice.
Both organizational forms share the characteristic of "passing-through" their income to the owner(s). Both also provide their owner(s) limited liability protection. But each has some distinguishing features, too. You, as a new business owner, will want to consider the differences as you choose the form for your enterprise.
A few of the main differences include:
· An LLC is easier to operate and administer.
· An LLC offers more flexibility in allocating percentage of profits or losses among the owners.
· Compared to a typical LLC, an S corporation offers more flexibility in paying its earnings to owners as either earned income in the form of salaries and wages or as distributions.
· An S corporation is easier to deal with for various tax planning purposes.
Before choosing one of these options - or a combination of the two – you should determine which features are most important to you and your business. We’ll help you do that.
Next time: Part 2
In Part 2 next time, we’ll discuss the benefits of an LLC, how it’s structured and things to consider when deciding whether to organize your business in this manner.
By Alfred Fricano
If you’ve ever had your wallet stolen or discovered that someone has hacked into your personal information online, you understand how time-consuming and annoying identity theft can be.
Canceling your credit cards, putting a hold on any outstanding checks, getting a new Social Security card and jumping through hoops to get the money back that someone spent on your behalf isn’t fun.
While identity theft is a threat year-round, tax-related identity theft is a growing problem this time of year.
What is tax-related identity theft?
Tax-related identity theft occurs when someone uses your stolen Social Security number to file a tax return claiming a fraudulent refund. You may be unaware that this has happened until you file your return and discover that a return has already been filed using your SSN. Or, the IRS may send you a letter saying it has identified a suspicious return using our SSN.
You’d think that if someone was going to put forth so much effort to steal your tax identity that they’d at least have the courtesy to pay your tax bill, right?
Instead, they have eyes for your big tax refund check. Yes, the one you’re counting on to pay for this year’s family vacation or as a nice down payment on a new car.
Fortunately, there are some simple ways you can prevent the crooks from swiping your money – and identity. Not only will these save you money, but they will also save you months and months of phone calls and headaches while trying to straighten out the mess.
1. Don’t let the IRS owe you a big refund. A big chunk of change each spring sounds great. But why wait to have access to that money? You can reduce the withholdings from your work paychecks so that instead of waiting around for a big check later (the crooks are waiting on it, too), you can have that money now. If you’re not used to that “extra” cash, sock it away in a savings account and pay yourself later.
2. Secure important documents. Store your important papers, like Social Security cards, in a safe and secure location, and don’t discard any documents with your SSN on them. Copies of tax returns should be kept in a locked file cabinet or safe.
Also, resist giving businesses your SSN or other personal information just because they ask for it. Often, it is not required, and giving out this information is risky.
3. Protect online information. You should protect personal computers by using firewalls and anti-spam or anti-virus software, updating security patches, and regularly changing passwords for Internet accounts with sensitive information, such as online banking sites. Do not make passwords simple enough to guess, like your address, birthday, wedding anniversary, etc.
4. Hire a professional accountant. The IRS is continually looking for better ways to protect taxpayers against tax identity theft. Unfortunately, there are still some who fall for email phishing scams and bogus websites, which attempt to steal their information. Certified Public Accountants (CPAs) are highly trained in tax preparation and have direct access to many important resources through the IRS that can help educate clients about avoiding and dealing with identity theft.
Alfred Fricano can be reached at 330.385.2160.