Written by Brandon M. Iddings, CPA, ChFC, MAcc May 31st, 2022
CONTRATULATIONS! YOU'VE DECIDED TO GO INTO BUSINESS FOR YOURSELF. WHETHER THAT MEANS YOU'VE DECIDED TO MONETIZE YOUR SIDE HUSTLE, OR TAKE THE PLUNGE AND GO ON YOUR OWN FULL TIME, THERE IS A LOT TO CONSIDER, AND IT IS CRITICAL IN THE EARLY STAGES OF YOUR BUSINESS THAT YOU LAY THE RIGHT FOUNDATIONS...
One of the most common questions that I hear from business owners is "how do I go about structuring my business", or some variation of that sort. Maybe you're thinking about setting up an LLC, but everyone you know is telling you to set up an S-Corp? Maybe you went into business with a friend or relative, and are wondering how is that handled for tax purposes? There is so much misinformation available out there that can get business owners into heaps of trouble, so I wanted to provide some insight into this first and crucial business step so that you can establish your business on a solid foundation that won't get you into trouble later. But first off, I need to clarify that I am not an attorney, so cannot make any legal recommendations. The advice that I present in this article is from a tax planning standpoint only, and I'd advise you to contact your attorney for legal advice.
With that said, my go to recommendation for small business owners is to set up an LLC, and here's why. LLC filings are usually relatively inexpensive, and less intensive than other legal entity formations (i.e., a corporation). An LLC also offers limited protection to its owners from some debts and lawsuits incurred by the LLC as opposed to a sole proprietorship where the owner has unlimited responsibility.
The benefit that I like most about an LLC is its versatility from a tax planning standpoint. For example, if you are the sole owner of an LLC, it is disregarded as far as the IRS is concerned. What this means is that for tax reporting purposes, you have the benefit of reporting as a sole proprietor (which is simpler and costs the least in tax prep fees) but you still get the benefit of having LLC protection. LLC's can also be taxed as partnerships if there are multiple owners, or as an S-Corporation if you make the appropriate elections with the IRS. This means that if you set up an LLC when you first establish your business, you can run as a sole proprietor for the simple tax reporting and lower tax prep fees, but you have the option as your business grows to do some tax planning and make entity elections that could save you thousands of dollars!
I would strongly caution you against simply setting up an S-Corporation or a C-Corporation right off the bat without proper research and tax planning. While S-Corporations have the potential to save business owners thousands in taxes, they are also more compliance intensive and expensive to run, and the IRS has certain requirements that need to be considered when owning this type of entity. I've seen many business owners blindly take the advice of a tax preparer when setting up their business and end up in over their heads and thousands of dollars deep in IRS penalties.
Going into business for yourself can be one of the most rewarding choices you'll ever make but could also be one of the costliest if not done properly and with careful consideration of all your options. It is always advised to consult with an attorney and tax professional when making these decisions as it could save you major headaches and lots of money in the long run.
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