This is a five part series on the best tax tips for entrepreneurs. If you have followed us either here, on EO Fire or any of the other podcasts or blogs we have been featured on, these five tips won’t be anything new. They aren’t sexy tips no one else knows about. It isn’t what the “guru’s” (who are these guru’s everyone refers to in that classic sales line??) don’t want you to know. As with most things in business, sports and life in general, it’s all about the basics, or fundamentals. I once heard someone say that when you are listening to advice you have heard before you should ignore the temptation to simply say “I already know this”. Instead ask yourself “am I living this?”. And so it goes with these tax tips. If you already know them, but aren’t implementing them, it’s time to pay attention.
What is a Business Entity?
If you have heard me talk or seen my writings anywhere at all, you have certainly heard me harp on the importance of choosing the right business entity, or legal structure, you operate your business out of. Your choice of business entity will impact you in two major areas, some might even say the two most important areas; tax liability and legal liability. Few choices you make will impact your business and taxes greater than your choice of entity.
So what exactly are we referring to when we talk about business entity? Your business entity is the legal structure you operate out of. When you hear people mention their Corporation, or LLC or say they are a “sole proprietor” they are talking about their business entity. On top of the legal and tax ramifications we talked about above, your choice of entity will also determine things like what tax forms you file, how you “pay” yourself and what type of annual paperwork you have to file with the state and IRS.
What Are My Options?
There are essentially four options when it comes to your choice of business entity:
- Sole Proprietor– This essentially means you never filed any paperwork with the state or IRS, you just hit the ground running. In this format you and your business operate as one in the same. It is by far the simplest and cheapest option for setting up, but also exposes you to the most legal liability and offers no tax benefits.
- Limited Liability Company (LLC)– In most states, an LLC can have contain several owners, or members in LLC language, or just one member, yourself. The LLC operates very similar to a sole proprietor, except for one major difference, it separates the owners from the business for legal purposes. From a tax perspective, contrary to popular belief, the LLC offers no tax benefits.
- S-Corporation– An S Corporation, or S Corp for short, is actually not an entity on its own. Instead, it is a tax election that an LLC or C Corp can choose to use. So from a legal perspective, the S Corp operates exactly the same as an LLC, it separates the owners from the business. Where the S Corp shines is on the tax front. Unlike an LLC or Sole Proprietor, the S Corp is not subject to self employment tax on the profits in the business. This can be a major tax savings for businesses operating at a profit.
- C-Corporation– The C Corp is a traditional corporation and has by far the most bad information out there. Unlike what the commercials on the radio might tell you, or what your well meaning family and friends may say, the C Corp is a terrible option for 99 percent of small business owners. Because of this, we will say our formal goodbyes to the C Corp here and not mentioning it as an option from this point forward.
Which is Best For Me?
OK we laid out the three options you should be choosing from (Sole proprietor, LLC, S Corp), we gave a little info on each, the next logical question becomes “which option is best for me and my business”. As with most important accounting decisions, I highly recommend discussing with a CPA you trust. If you don’t yet have that, contact us, we would be happy to help. But I have been able to establish a set of ground rules that will give you a good idea which of these three options is best for you.
Sole Proprietor- If your business is making less than $35,000 a year in net income (income left after expenses), and you have no concern for legal protection, you are just fine operating as a sole proprietor. Save yourself the time and money involved in incorporating and keep things simple.
LLC- If your business is making less than the $35,000 net income mentioned above, but you are concerned with legal protection, an LLC is the choice for you. There are no tax benefits and you will have to spend some time and money getting it started, but the peace of mind the legal protection may give you is well worth it. An LLC also makes an easy transition to an S Corp when the time comes to make that move.
S Corp- If you are making over $35,000 per year net income and aren’t an S Corporation, you are throwing money away on taxes. Period. End of story. If your current CPA tells you it’s not worth the hassle, get a new CPA. At $50k net income you are saving around $5,000 a year in taxes. At $100k a year you are saving about $10k in taxes. And as your income continues to rise your tax savings do the same. So if you are at that $35k per year net income number, you should absolutely be making an election to be taxed as an S Corp. It’s by far the biggest tax “loop hole” there is. And there is still time to make this move for 2015, so contact a CPA you trust today!
Make an Informed Decision
The accounting and tax world is filled with terrible information. There’s a lot of people willing to give “free” information that somehow benefits them and it’s usually terrible advice. The area I see this happening the most is with business entities. There is a TON of bad information out there. So I highly advise you use these guidelines to start thinking about which is best for you and then seeking out a CPA you trust to discuss the decision in depth. In my opinion it’s the most important decision you will make when it comes to your business tax and accounting.
In Part II we will discuss bookkeeping and accounting, the foundation of a successful business.