What Type of Business is Your Business?

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“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.

  1. 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.
  2. 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.
  3. 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.
  4. 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.
  5. 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:
    • legal
    • medical
    • actuary
    • accounting
    • financial services
    • consulting
    • athletics
    • performing arts
    • any business whose reputation is the major asset in the business such as possibly realtors.
  6. 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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