If you're a new business owner, you may wonder whether you should incorporate your business. Well-meaning friends and business colleagues may even have encouraged you to look into the question of "forming a LLC vs. Scorp."
It often is a good idea to incorporate your business for two basic reasons. First, you usually obtain some liability protection. With a corporation or LLC, business creditors may only be able to get repayment from the LLC or the corporation. For example, if the corporation borrows $50,000 for some business purpose and then can't repay the loan, the creditor may only be able to recover the loan from the corporation. If the corporation doesn't have any money, the creditor won't get repaid. And that might be true even if the shareholders who own and operate the corporation have money.
This liability protection isn't perfect. Many situations exist where a business creditor can look beyond the assets of the corporation and to the managers and owners of the business for repayment. But when you incorporate your business, you always get additional liability protection over other business forms such as a sole proprietorship or a general partnership.
The right corporate choice can often produce big tax savings.The tax law views corporations either as C-corporations or S-corporations. C corporations can provide all their employees, including shareholder-employees, with generous tax deductible fringe benefit packages. S-corps allow shareholders to avoid double-taxation on profits and can often allow shareholder-employees to save on self-employment taxes (FICA and Medicare).
You have undoubtedly heard of limited liability companies, also known as LLCs. You may therefore be wrestling with the "forming a LLC vs S-corp" question. An LLC is another way to get liability protection. And in many cases, LLCs represent a superior form of liability protection. An LLC doesn't require as much red tape as a corporation. An LLC is also a chameleon for tax purposes, in other words, an LLC can be treated as just about anything for tax purposes. An LLC with one owner (called a member) can be treated as a sole proprietorship, a C-corporation, or an S-Corp. An LLC with two or more members can be treated as partnership, a C corporation, or an S-corporation.
You can set up a corporation or LLC yourself. Or, you can pay a professional to do the work for you. The actual set up isn't difficult. Setting up a corporation or an LLC in Florida requires a simple one page form you can download from the Florida Secretary of State's web page. But one huge advantage for seeking profesional advice, is that the they can answer your questions about the liability protection you want to achieve, as well as establishing an agreement with your partners on an exit strategy.
Whether you set up a corporation or an LLC, you have choices to make about how the new entity should be treated for tax purposes. For example, if you set up a corporation, should the corporation be a C corporation or an S corporation? If you set up an LLC, should it be a partnership, a sole proprietorship, a C corporation, or an S corporation? You should not perform this analysis yourself. People who don't understand the tax laws tend to make very expensive mistakes-mistakes which can be difficult and sometimes impossible to fixOne other point needs to be made concerning the option of forming a corporation or LLC: The business pays extra costs by incorporating-costs beyond those required to set the thing up. In Florida , for example, you can expect to pay additional annual license fees ($50 for an LLC) or ( $ 150 for corporate) annual license fees depending on the type of business. You may increase your personal property taxes by setting up a corporation or an LLC. You will pay more for your tax return if you end up with an entity that, for income tax purposes, is a partnership, C corporation or S corporation. Finally, you will need to put owners on the company payroll (even if the owners are the only employees!) and this will increase both your payroll accounting work and subject each owner to roughly $189 in state unemployment taxes and $56 in federal unemployment taxes.
Let us try to distill all of this down to a few rules of thumb:
Rule 1: If you're a sole proprietor making profits equal to what's a fair salary for someone who does your job (or less) and you want liability protection, you should usually set up a single-member limited liability company. You'll keep your accounting and taxes very simple because for tax purposes, you'll still be a sole proprietor. Yet you'll get a degree of liability protection. Usually, a sole proprietor making less than 35,000 after expenses should choose this option.
Rule 2: If you're a sole proprietor making profits in excess of what's a fair salary, you should probably set up an S corporation. Your accounting and taxes will become a little more complicated, but you can often-times save thousands of dollars in self-employment taxes.
Rule 3: Partnerships and groups of investors will usually want to set up a limited liability company, or an S corporation, or a C corporation. While none of these options is terribly tricky, choosing the optimal entity in these cases is tricky. If your setting up a service business that will pay you a salary, you should probably use an S Corp. If you are going to aquire rental real estate as an investment, you should probably use an LLC. You want to get able tax planning help in order to pick the best business entity.
Rule 4: If you consult with your attorney for an explanation of the legal reasons for either setting up a corporation or a limited liability company, make sure to ask about the difference between tort liability (which is the sort of liability you have if you accidentally drop a hammer on someone's head) and non-tort liability (which is the liability you have to creditors if your business gets into trouble). A corporation or limited liability company will not shield the owner against liability for his or her own tort actions. It's also very possible-again, ask your attorney about this-that a corporation or limited liability company will not shield the owner against liability for tort actions on the part of employees.
Give us a call at 305-668-3099 to help you in making this important decision.
See Planning Tools for Business Owners, where a number of articles can be found regarding starting a business, as well as various charts and tables for comparison of the vaious entities including LLC's, LLP's, S Corporations, and C Corporations
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Don@DrDebit.com
