Prepare, prepare, prepare. As a recession is bearing down on us all, figuring out how to prepare for economic downturns is something you should be concerned with in your business. I know I am.
Now, while you and I can’t prepare for every eventuality, we can put systems and plans in place that will help our businesses face the most difficult ones.
As one example – are you prepared for the possibility of a natural disaster striking your area? Depending on what you do, that can have catastrophic effects on your business. You can come up with a plan. The Small Business Readiness for Resiliency program is a good resource to get you started.
We can help you prepare in other ways. Starting with your bookkeeping situation. There are things you can do now –moves you can (and should) make – to help you save money and ensure that everything is set up properly. Use this right here (sooner is better than later):
“Real World” Business Strategy Note
Saving by Restructuring Your Business?
“Change before you have to.” – Jack Welch
How you organize your operations makes a big difference to your bottom line. The same holds true about structuring your business. You may have different reasons for changing your company structure, such as an expansion of personnel, products, funding; profitability; or asset protection.
While we here at Mark Perlberg CPA PLLC don’t do taxes, we do focus on advising you in making the right moves for your business, which includes choosing the right business entity type.
Types of structures
One of the first and more variable expenses for a business entity is taxes. Yet the same complex taxes that can save a company and its owner money can also mean more expensive tax prep and setting up your new business structure. On the other hand, the more complex the structure the greater your personal protection against business debt.
Here’s a look at some of the most common entity types and their expenses and potential savings.
Sole Proprietorship. This may be your best path if you like doing most of the work, taking all the chances, and reaping the rewards. This is also the most common type of business entity – almost 30 million of them in the U.S.
Sole proprietors are liable for the company’s liabilities, debt and losses – your personal assets are on the line. You pay the taxes of the company, often through quarterly self-employment tax; your income is also taxed.
These entities are cheap (if not free) to form but obtaining future capital to expand can be harder than with other business structures. Sole proprietorships however are also the most likely business entity selection to be audited.
Partnership. You own and operate the business with at least one other person.
There are general partnerships where the company is owned by two or more individuals who run it as partners or co-owners; limited partnerships with at least one general and one limited partner; limited liability partnerships where owners aren’t held personally responsible for the debts or other partners’ actions; and LLC partnerships that can have two or more owners, who are called members and whose personal assets are protected.
Your personal financial liability is diffused; so are your profits. Partnerships must file an annual information return to report the income, deductions, gains, losses, and so on from operations but it doesn’t pay income tax.
Many in partnerships and other entities can take a 20% tax deduction on their “qualified business income” (QBI) – check with us on this, though, as there are a lot of rules. It’s also possible to have a spouse as your passive partner in your business. This will allow you to eliminate self employment tax on the portion attributable to spouse.
Limited Liability Corporation (LLC). An LLC exists as a separate legal entity that protects its members from personal liability for business doings.
Registration costs are generally in the low to mid-three figures, depending on your state. Services are available for you to set up an LLC, too, which are usually quick and reasonably priced. Raising capital can take more work, time, and money than with other entities.
For taxes, a domestic LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and elects to be treated as a corporation. LLC’s can become C-corporations or S-corporations.
Corporation and S corp. Money and tax considerations get more complex with these entities. (We’re happy to advise further – give us a buzz.)
A corporation is a separate taxpaying entity that can elect to be taxed as a pass-through entity – a “subchapter S election” that requires filing an IRS Form 2553. Other conditions include a limit on the number of shareholders.
S corps pass corporate income, losses, deductions, and credits through to shareholders, who report the “flow-through” of income and losses on their personal tax returns. They also have to pay FICA taxes on salary compensation to owners and not on the remaining profits.
The IRS stresses that S corp owner-employees must be paid “reasonable compensation” for their services. Some states also have special rules for S corps. We have many business owners, including real estate agents and house flippers electing to be S-Corps. But being a realtor or flipper does not always mean an S-Corp is beneficial. Make sure you talk to a QUALIFIED advisor before making deciding an S-Corp is appropriate! Also, Reasonable Comp is NOT a % of net income!
C corp. Your corporation can also elect to be a C corporation. The owners are taxed only on the amount of earnings they receive as dividends — not the earnings the corporation retains. Owners can sometimes even get out of capital gains taxes when they sell certain stock of the company (on this and all tax matters, check with us).
C corps can be yet another structure to protect assets – and attract investors as well as live under a lower tax rate than S corps. Nevertheless, a recent study found that some startup C corps would have saved money if they’d formed as LLCs.
In a C corp, the company itself is taxed on income and any additional profits left over and distributed to shareholders (usually as dividends) are then subject to personal income tax. With C corps, planning with us is especially key to avoiding double taxation and other money drains. It can be a VERY appealing structure for certain kinds of businesses, because there is a flat taxation rate, and it isn’t as high as ordinary income.
For our clients, we may soon be recommending C-Corp Management Companies so they can shift income off of their 1040’s, which can potentially qualify them for qualified business income deduction (20%), and also allow us to create tax deductible fringe benefits! Some house flippers may also consider this entity selection because they’ll be able to keep their retained earnings for future flips instead of paying double taxation on dividends.
But it depends on a few things to be “just right” … or it could make things worse.
We’re here for you in these difficult times.
On your team,
Mark Perlberg CPA PLLC