COVID Funding Tips for Small Businesses
Which entity is best for your new business, an LLC, or Corporation? When you form a new LLC or corporation, the process is easy, with so many online websites.
Filing the articles with a registered agent is the easiest part of the process. The challenging part is determining how your corporation or LLC should be taxed at a federal and state level and make sure you have a complete formation, one with real liability protection, not just filing the articles, which has ZERO protection.
Ask these Questions to Help You Determine is an LLC or Corporation Best?
Here are some of the key questions we recommend you evaluate before you form an LLC (which may be taxed in four different ways) or a corporation that may be taxed as a C corporation or an S corporation.
- What is your business, and how does this affect your choice?
- A personal service corporation, in the past, was a flat 35%; but since the 2018 tax cuts, that has now been reduced to 21%
- 20% deduction for pass-through income, with some restrictions
- Are you investing in real estate, or do you flip real estate?
- Are you an e-commerce seller with potential sales and state income tax requirements?
- Do you own real estate? If so, are you a dealer or investor? How many properties do you own? How much total equity and what percentage of your total net worth is all the properties?
- Do you have partners?
- Is it a domestic partner in a community property state (there are 9)? This comes into play with a single or multi-member LLC.
- Is it a foreign partner in another country? If so, is there a tax treaty with your partner’s country?
- Do you plan to have a buy-sell agreement?
- Is one partner an investor? This has a big impact on how your LLC is managed.
- Do your partners have an SSN or ITIN (this is important for banking, U.S. merchant account, and sales tax registration (a few states).
Additional important questions include:
- What is your personal income, separate from the income you may earn from the operating business? This is important for U.S. residents attempting to save self-employment taxes, which are 15.3%, with a limit of $137,700 in 2020.
- Will your business develop net worth or value over time, or is it the only value-based upon your individual efforts (a consultant or freelancer)? It is challenging to protect the shareholders of an S corporation.
- Do you need to develop business credit to help grow your business? After formation, business credit bureaus will start a file, and most businesses look financially naked, with no companies reporting to build a solid business credit score.
- Will you keep profits as retained earnings for future growth and expansion? This is especially important with partners.
- Do you have an exit strategy?
- Do you have a tax firm onboard?
- Are you concerned about income on schedule C and having a higher risk of a personal audit? Perhaps a single-member LLC disregarded owned by you with earned income is not the best option.
- Are you planning to move to another state or country in the next 1-2 years? Redomicile or foreign qualify and withdrawal?
- Do you already have other corporations? Controlled group rules are complex.
- Are you a U.S. citizen or resident alien?
- Which state or country do you live in currently?
- Which entity is best for year one vs. year two and three in your business? If you need to make a change in the future, what are the cost and ramifications?
As you can tell, there is a lot involved in determining is an LLC or corporation best.
Over the past 23 years, our experience is that most people guess or select an LLC but have no idea how it should be taxed or if that was the best option.
This typically leads to expensive taxation and legal issues down the road, especially if the business takes off.