How Pick The Right Entity?
This is probably the most important question you should ask yourself before starting your business. The fact is that there is so much information online and it could be very confusing to know whether you should pick an S-Corp, C-Corp, Partnership, Sole Proprietorship or an LLC. So what I am going to do is break it down for you.
Rule of Thumb in the Tax Industry
The rule of thumb in all tax strategies is for you to operate your business as S-CORP. Of course as with many tax rules, this depends on your type of business.
Business entity advice isn't as easy as suggesting that you use S-Corporation for a business or a partnership for real estate. Some businesses are better off taxed as partnerships, and sometimes real estate should be held in an S-Corp (such as when you are planning to quickly sell the real estate)
Having said that, a majority of businesses should listen to the "Rule of Thumb". Now there are a few basic factors to look at before making this decision.
You are a legal resident of the U.S.A
You have less than 100 Shareholders
If you checked off these 2 requirements then I will explain why you want to operate with a S-Corp.
The fact is that this entity is going to save you the most money hands down if you have a profit of $10,000 or more.
S-Corps are pass through taxation entities, which make you pay the taxes of the profits of the corporation. Why is this great? Because the corporation does not pay Federal Taxes at a corporate tax rate. So whatever profit your corporation has is going to pass through to you with a schedule K1 so you can pay the taxes at your ordinary tax bracket.
The truth about the S-Corp Election
Many people are confused by what I am about to say because it trumps what online information says. In the legal industry and the accounting industry we usually keep it simple for people, however, I think this causes more confusion about the S-Corp election.
The S-Corp is not a corporation. S-Corp is just an election we make with form 2553, which is a form filed with the IRS and we can file this form for a General Corporation or an LLC.
Types of Entities
There are only a few type of entities you can file for which are:
General Corporation for Profit
General Corporation Non for Profit
LLC
Trust
LLP
General Partnership
Limited Partnership
Types of Elections
A General Corporation will have an automatic election as a C-Corp unless you file form 2553 to be taxes as S-Corp
C-Corp
S-Corp
An LLC will automatically fall into being taxed as a Sole Proprietorship (Schedule C) if you are the only owner and it will automatically be taxed as a Partnership if there are 2 or more members and no other forms are filed. However, an LLC can also file form 2553 (S-Corp Election) for your LLC to be taxed as an S-Corp whether you are the only owner or 100.
Sole Proprietorship
Partnership
S-Corp
C-Corp
What About C-Corp Election?
C-Corps are not going to be used as often for businesses unless they have more than 100 shareholders. That is why all public companies in the stock market are C-Corps, because they have sold their stock to more than 100 shareholders.
C-Corps also have to distribute the profits to their shareholders so that means that the corporation will pay corporate taxes on the profit and the shareholders will also pay taxes on the dividends received. This is what we call "Double Taxation."
In this company we use C-Corps, but we do not use them for regular business as you may be thinking. We use them in away that they serve as bank to us and also as elements to tax strategies we build. This is why we are not against C-Corps; we just use them in a different way.
What About Being taxed as a Partnership?
Partnerships are great, I personally love them when creating tax strategies between partners. Now the benefits of taxation are the same as having a S-Corp. The difference between a partnership and the S-Corp election will be more legal than anything else. It basically boils down to the liability of the partners and how expenses are allocated.
"Suppose you both need company cars. You want to drive a Ferrari and your friend want to drive a Honda. Chance are that your friend doesn't want to pay for half of your Ferrari. If you formed your business as an S-Corp, you would not have a choice. Since your friend owned half of the S-Corp stock, her/his share of the income would go in part to pay for your Ferrari. In a partnership, you can specially allocate deductions, You could allocate the cost of the Ferrari to you and the cost of the Honda to him/her. You might want to do the same with home office deductions, travel, meals or entertainment expenses. "
I don't want you to battle between a partnership or S-Corp for you and your partner because you can pick both! Yay! How do you do this, you may ask? By each partner having an S-Corp and then those 2 S-Corps being member of an LLC taxed as a Partnership. This is a very common tax strategy that maintains your tax banefits and solved the legal problem you may have in the future.
P.S. You do not need to be a legal resident to qualify as a Partnership and enjoy the tax benefits of it (which are very similar to an S-Corp)
When not to Form an LLC?
This will depend on the State that you want to operate from. In this case I will talk about the State of California. There are different business professions that are not allowed to form an LLC. These are basically services in which you offer a personal service, such as: Doctor's private practice, Realty Services, Attorney Services, Consulting and more.
Make sure that you do not fall into the category of Personal Service Corporations so you may open an LLC with no problem.
Another thing to consider when you are planning to open an LLC in the State of CA is the LLC Fee. What is that? Well when your revenue is greater than $250,000 and you are an LLC being taxed as a Partnership or a Sole Proprietor you have to pay the special "LLC Tax". This can easily be avoided if you are elected to be taxed as an S-Corp with your LLC.
Conclusion
Do not get caught up in the trap of thinking that one type of entity fits all or that should even only have one entity as part of your tax strategy. There is a lot of flexibility when you have a clear understanding of the different entity types and your tax adviser has a clear understanding of your goals and circumstances.
