Sole Proprietor, Corporation, LLC or LLP ?

Once your business is up and running, you now must decide which business entity will be best for you when considering income taxes! Yes, we must pay our taxes! So, I asked Mr. Dunn to share some thoughts on that subject!

As you know, Chad has joined our group and will give us some bits of information from time to time to help with our taxation concerns. If you want more detailed information, please feel free to contact him directly! So here is an article that Chad published recently concerning business entities. I hope it helps!

How Should You Set Up Your New Business?

When you start a business, you have many choices to make. One key decision is choosing the form of business entity you will operate under. For starters, you can set up your business as a Sole Proprietorship, C-Corporation, S-Corporation, LLP (Limited Liability Partnership) or an LLC (Limited Liability Company). How can you narrow that list down?

Small businesses typically decide against a C-Corporation, because C-Corps generate two levels of federal income tax. The C-Corporation pays one level of tax when it files its federal corporate tax return, Form 1120. A second layer of tax is imposed when the C-Corporation's profits are distributed to the shareholders as dividends. Those dividends are reported and taxed on the individual's federal tax return, Form 1040. Together, these two levels of taxes are referred to as "double taxation." In addition, state taxes also typically apply to both C-Corporation profits and distributed dividends. Overall, the tax picture for C-Corps is far from ideal for small businesses. Even the current 15% tax rate on dividends does not completely do away with the sisadvantages of double taxation.

Doing business as a sole-proprietor eliminates the double taxation curse. There are no corporate taxes to pay, and you only pay individual taxes on your net profits, typically reported on Form 1040, Schedule C. However, as a sole proprietor, you lack the legal protection that corporate status gives you. Owners of corporations enjoy limited liability, but sole proprietors do
not. Simply stated, if you're a sole-proprietor, your personal assets are at risk if the business is sued-very risky indeed!

That leaves LLCs, LLPs, and S-Corporations. LLPs and LLCs are similar in many ways. One key difference is that LLPs must be owned by more than one individual. Remember, the "P" in LLP stands for partnership---by definition a single individual can't own a partnership. So if you had an LLP with two owners and one died, serious problems that might even cause the business to close could result.

The choice quickly narrows to an LLC or an S-Corporation. Which is more appropriate for your business? Well, they are both "pass-through" entities that allow you to avoid double taxation, operating a business without paying corporate taxes. Net profits
are reported by the owners in their individual tax returns, and both also offer protection from unlimited liability. Your liability will be limited to your investment in either entity.

When choosing between an S-Corporation and an LLC you need to consider many things. What may be appropriate under one set of circumstances may not be in another. Every business is different, and every owner has different needs and expectations. Let's review the attributes of each type of entity to help you decide.

THE S CORPORATION

Created in 1958, the S Corporation was, for many years, the standard form of organization for conducting a small business. S Corporation status provides a way for you to avoid the double taxation imposed upon C Corporations and their shareholders. One advantage of the S Corporation is that income is taxed personally to the shareholders. However, your personal risk remains limited to your investment. In other words, double taxation is avoided and
you get the protection of limited liability.

Your corporation chooses "S-Status" by filing a special election, Form 2553. Bear in mind that the "S" status of the Corporation only impacts taxes. Shareholders of S Corporations have all of the same legal protections as those in C Corporations. But as once said by a famous Tax Court judge, "A corporation is like a lobster pot. It's easy to get into...difficult to get out of." In other words, once you have established an S Corporation, it would first have to be liquidated if you wanted to change to an LLC, and
liquidation of a corporation can result in taxable gains to the
shareholders.

THE LIMITED LIABILITY COMPANY (LLC)

LLCs started in 1977 in Wyoming and have quickly become a popular form of business entity across the country. By default, LLCs with more than one owner (member) are taxed as Partnerships, while single-member LLCs are taxed as sole proprietorships. As with S corporations, with an LLC you only pay taxes with your personal return. However, if you decide to do business as an LLC, you are not stuck with it. Simply by filing a Form 2553 at the appropriate time, an LLC can become an S Corporation without having to liquidate. There is little risk of triggering a tax by changing from this form of doing business.

SETTING UP SHOP

Establishing an S corporation is relatively simple and nexpensive. An attorney, or even you, can form a corporation by completing a series of "boilerplate" documents. These forms require you to complete the following information: who will own the business, the business's activity, address, and other miscellaneous details. Aside from being registered as an "Inc.,
Co. or Corp.", a corporation can also be registered as P.C. (Professional Corporation). This designation is for professionals who choose to operate in corporate form and is popular with doctors, lawyers, and accountants.

An LLC requires a bit more work to get started. Articles of Organization, to be filed with the state and an Operating Agreement (like a Partnership Agreement), should be drafted by a lawyer. In addition, business information about the LLC must be placed in a published ad to give notice to the public that the company is being started. An LLC can choose to be registered as a
P.L.L.C. (Professional Limited Liability Company) when its owners are licensed by the state to engage in a professional practice -- doctors, lawyers, accountants, etc.

DISTINGUISHING CHARACTERISTICS

An S Corporation might be more restrictive than an LLC. There can't be more than 100 shareholders in an S Corporation. In addition, only individuals, estates, and qualifying trusts are permitted shareholders. An S Corporation may not have any non-resident alien shareholders. There can only be one class of stock ownership. Adding a second category or class of ownership terminates the "S" Election, which could lead to unintended and unexpected tax consequences. The income and expenses from an S Corporation are allocated on a per-share/per-day basis. Your businesses' net income, after paying you a reasonable salary, would not be subject to self-employment taxes on your individual return.

The amount of your investment in the S Corporation--your cost
basis--includes:

1) Your contributions of cash & property
2) Your share of S corporation profits not distributed to you
3) Loans made directly to the Corporation by you


This "Basis" calculation is important because it is your tax cost. The more you have invested, the more "write-offs you can claim when there are losses.

LLCs offer more flexibility than S Corporations. They can have an unlimited number of owners and any person, business or trust can be a member, or owner. With an LLC you can choose to allocate particular types of income and expenses between the owners. Doing this can get pretty complicated, so be sure to speak with us about "special allocations." On the negative side, the status of the business's net income as subject to Self-Employment taxes is
unclear. Current thinking is that reasonable compensation should be paid in the form of guaranteed payments, subject to SE tax, with the balance of income - - attributable to capital or the work of employees - - not subject to SE tax.

Your basis in an LLC (your tax cost) includes:

1) Your contributions of cash & property
2) Your share of LLC profits not distributed to you
3) Your share of the LLCs debts to others. (In an LLC, loans to the company can increase your tax basis if you are personally liable for them. In an S corporation, only your direct loans to the company can increase your tax basis.)

LLCs provide more ways to increase your tax basis. This illustrates a significant advantage of LLCs over S Corporations. Because of the way these calculations are done, your cost basis may be higher for an investment in an LLC than if you set up shop as an S Corporation.

CONCLUSION

Many businesses should probably start as an LLC. Advantages include
flexibility of ownership, ability to gain tax basis from liabilities, and pass-through of profits and losses. If a corporate entity is determined to be required later, the change from LLC to corporation is quick and generally tax-free.

Additional helpful tips are located at: http://www.lcdcpa.com/Newsletter.htm

Thanks Chad, for the great information!

Five Lessons to Cause You to Think About How You Treat People!

So often I hear the words spoken "In the end, the one with the most toys wins!" In business so many of us tend to forget some of the more important things we have learned along the way and focus on getting "all the toys" So as we work on our proven imcome opportunity or that start work from home business, try and remember that the way we treat people is also part of the image we portray. Is the image one of a person that others would aspire to be or aspire to do business with? To me, at the end of the day, I might not have "all the toys" but I have piece of mind and have built relationships that will continue to come back to me time and again to do business!

The following story is one of five that were emailed to me from a friend and although I have seen these before, I though it would be a perfect opportunity to post a few of them over the next few days,especially since I just wrote about images and creating an image! I think it also fits quite well with the recent "7 Habits" posting that I did as too!

1 - First Important Lesson - Cleaning Lady.
During my second month of college, our professor gave us a pop quiz. I was a conscientious student and had breezed through the questions until I read the last one: "What is the first name of the woman who cleans the school?" Surely this was some kind of joke. I had seen the cleaning woman several times. She was tall, dark-haired and in her 50s, but how would I know her name? I handed in my paper, leaving the last question blank. Just before class ended, one student asked if the last question would count toward our quiz grade. "Absolutely," said the professor. "In your careers, you will meet many people. All are significant. They deserve your attention and care, even if all you do is smile and say "hello."
I've never forgotten that lesson. I also learned her
name was Dorothy.

The 7 Habits

Several years ago Dr. Stephen Covey wrote a book titled "The 7 Habits of Highly Effective People". Although a lot of time has passed and a lot of other reading has taken place since then, I always come back to a synopsis of those habits (newspaper article based on an interview with Dr. Covey) that I keep on the side of my desk. I believe that one can apply those seven habits to themselves, regardless of what it is you do; business person, teacher, student, laborer... I thought I would share them with you with the hope that you might find them useful in your daily endeavors!

The 7 Habits...
1- Be Proactive. You are responsible for your life. Decide what you should do and get on with it.
2- Begin With The End in Mind. Think of how you want to be remembered at your funeral. Use this as a basis for your everyday behavior.
3- Put First Things First. Devote more time to what's important but not necessarily urgent.
4- Think Win-Win. Have an abundance mentality. Seek solutions that benefit all parties.
5- Seek First To Understand, Then to Be Understood. Don't dive into a conversation. Listen until you truly understand the other person.
6- synergism. Find ways to cooperate with everyone. Value differences between people.
7- Sharpen The Saw. Continually exercise and renew four elements of yourself; physical, mental, emotional/social, and spiritual.

I was going to hold this post until Friday and give you the weekend to ponder it, but I will be out a good deal of the time tomorrow, so here it is! I believe that by practicing those principals, we can be both better business people and just plain better people!


If this post has intrigues you, you can find the book on Amazon at the this link.

Making Your Presence Known!

I couldn't resist, thought I would also share a sunset photo from the New Jersey Shore! I have always enjoyed looking at things through a camera lens, and sunrises, sunsets and seascapes are just so much fun!

All Work and no play...

It is Monday, May 01, 2006 and I took the weekend off to get some things done around the house. There are a number of projects that I have undertaken and just enjoy doing the work but find it difficult sometimes to find the time. So, I decided to take some time for play and for some of those projects as well!

Our Hummingbirds have made it back from their winter journey and since the feeder my wife hangs out for them is only a few feet away from the patio door, I get some great photos; thought I would share one with you!

I started with a New Jersey Blue Claws (Phillies double A team) baseball game on Friday evening. It was my grandson's first baseball game, although I am confident he will not remember it as he was just a year old last week! Then I got some work done that has been put off, as I mentioned! I did not look at my computer or the work on my desk.

By now you can see where I am going; you will work hard when you work for yourself, not necessarily physically hard, but you will put in a lot of time and certainly a lot of effort, especially for a new business! So, do not forget to take some time off for the things you enjoy. Charge that battery and then get back to work!

Another post to follow shortly!