“The beginning of the work is the most important”– Plato
Probably the most frequently asked question is “What type of entity should I conduct business in?”
Obviously, every situation and business is different, but I thought I would give some general rules based on an analysis of the new tax law, that will serve as some guidance, I would bet that few of you have gotten this information from your accountant.
- If you expect losses when you first start your business or for a short period of time after you start up, you should operate as either a sole proprietorship or LLC. The reason is that if you have losses, you can use those losses on your personal tax return. If you were a corporation, these losses might be trapped in the corporation and only used by the corporation. Once losses are not a problem, you can always change to another entity.
Note: If you have a business that has high liability exposure, you want to to the LLC route and NOT operate as a sole proprietorship due to the unlimited liability exposure of sole proprietors. If you are starting up a network marketing business, your liability exposure is small. Thus, starting off as a sole proprietorship is usually best.
- If you want to accrue capital for future marketing, operate as a C Corporation: The new law taxes corporations at a flat 21% rate. However, you will need a good business reason documented in your corporate minutes or you can be hit with an accumulated earnings penalty. See a good accountant or lawyer about this.
- If you have several owners and want to distribute most or all profits annually, operate as an S Corporation. This usually results in the lowest overall tax due to the new 20% pass through deduction.
- If you expect to operate your business for at least 5+ years and then want to sell out, become a C Corporation. C Corporations, who qualify as small business corporations, can have a BIG benefit, When the stock is sold, the stockholders can avoid all tax up to $10 million in gain. Yes, they can sell their stock and avoid tax on the first 10 million dollars of gain. However, you have to be in existence for at least 5 years and have assets of less than 50 million.
Also, you can’t qualify for this benefit if:
• A service business in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services
• A banking, insurance, financing, leasing, investing, or similar business
• A farming business
• A business involving the production of products for which percentage depletion can be claimed
• A business of operating a hotel, motel, restaurant, or similar business.
- If you are a specified service business and make over $415K of taxable income ( married) or are single and earn over $207,500, you should consider being a C corporation since you won’t be eligible for the 20% pass through deduction.
A specified service business is one that is:
• financial services
• performing arts
• any business whose reputation is the major asset in the business such as possibly realtors.
- If you are NOT operating a specified service business (such as a networking business or franchise), consider operating as either an S Corp or C Corp. This is especially true if you are married and earning over $415K or taxable income or over $207,500K of taxable income and single since there are limitations to the 20% pass through deduction based on wages. Being a corporation will allow you to avoid these limits with wages.
Hopefully, this analysis will give you an idea of how to choose the best entity for you from a tax standpoint. Feel free to print this out as a reference and also to show your friends.
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