How the IRS vs. How the Law Views Your Business

How the IRS vs. How the Law Views Your Business

Tax Season has ended and all the CPAs and tax prepares can take a breath.  But before small business owners forget about income taxes I wanted to discuss something that is often confusing. What is the difference between how the IRS see my business versus how the law see it?

When setting up a business you need to take into consideration the Tax Consequences and the Legal Consequences.  Business Owners often don't know there is a difference, and there wasn't one until LLCs were widely available in the 1990s. With the introduction of the LLC business owners could chose how they wanted their newly-formed legal entity to be taxed.

An LLC, my favorite legal entity, protects other members of the LLC and the personal assets of the individuals from legal ramifications if the LLC is ever involved in a lawsuit.  But an LLC is not a recognized legal entity by the IRS.  Because of this you have the option when setting up the LLC to be taxed as a disregarded entity (only available for single member LLC),  a corporation, or a partnership.

  • A disregarded entity is taxed as a Sole Proprietorship as a part of your individual tax return.
  • A corporation can be taxes as a S-Corp or a Normal Corp
    • S-Corp is like a partnership where net income is passed through to the members of the LLC to be taxed on their personal tax return
    • A Normal Corp doesn't pass net income to the members but pays its own taxes and distributes profits through dividends
  • A partnership is a pass-through entity.  All net income is passed through to the members to be taxed on their personal return.

If you own an LLC or are planning on starting one why would you want to go through the hassle of filing several forms and filing an additional return?

  • If your plan is to make money with the LLC (doing it as more then a hobby), then you have to pay self employment tax (Social Security & Medicaid) on any net earning if it is reported as either a Schedule C or Partnership.  That is an additional 15% tax on top of your normal income taxes.
  • As a S-Corp or Corp you do not have to pay self employment tax on net income passed to you.  You do have to pay yourselves a reasonable W-2 wage but the remainder of the net income is not subject to the additional 15% tax.

I personally believe the benefits of filing as an S-Corp or Corp out-way the cost:

  • You won't pay self employment tax on net income.
  • You would no longer have to make estimated tax payments because you would be paid a W-2 wage.
  • And you would have a clear separation of your business from your personal finances

Before 2017 is over consider filing form 8832 to request your LLC be taxed as a Corp and form 2553 if you want it to be taxed as a S-Corp.  Hopefully the above information is helpful in making your future tax decisions. If this process seems too complex to tackle on your own, or you have any specific questions, then please contact Walston Advisory Firm.

Email: info@walstonadvisoryfirm.com 

Phone: (434) 515-1669.

 

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