(Don’t Flub Your Business Structure)

Zen Mensch Accounting
You launched Herman’s Hermetically-Sealed Hermits last year.  Now your CPA is telling you it was set up all wrong. Triple H was set-up as a C-corporation, but it probably should have been an S, or maybe even a “single-member LLC.” Huh?

My company, ALSD, incorporates businesses and organizes LLC’s. This year Triple Hcame to me for tax preparation, but  first I had to unwind the erroneous structure. A very brief summary of  the most popular forms of business ownership:

Sole proprietor: You are not incorporated, have no partners, and file Schedule C for self-employed individuals as part of your personal income tax.   You can have a “d/b/a” and employees.  There is no firewall — if Mel’s Melatonin sole proprietorship is sued for malpractice, Mel’s Bonnet Shores beach cabana is fair game.Single member LLC:  Same as above, but limited liability protection . Some states charge annual franchise tax or registration amounts (RI and Mass, yep, $500).S- Corp::  Legal firewall, and major owners are paid primarily through salary; and Mel’s Melatonin, Inc. would  file a separate tax return.  But as a “pass-through entity” any resulting income or loss is reported on the shareholders’ personal tax returns .  There are some significant tax savings available to S-corporations. State fees may apply. I am partial to S-Corps in the right circumstances.

Multi-member LLC:  Legal firewall, and a separate tax return but different business structure and more flexible rules for ownership –e.g.  S-Corps are limited to 100 owners and these must be U.S. citizens. No such restrictions with LLC’s.  LLC’s are essentially partnerships but may choose to be taxed as corporations.  Confused yet, Mel?!

C- Corporations: As opposed to S-Corps and LLC’s, these are not pass-through entities.  Mel’s Melatonin would pay its own taxes. C- Corps are less popular for smaller businesses because of the possibility for double taxation.  However there can be distinct benefits for larger entities. Publicly traded entities must be C-Corps and they tend to be the preferred choice if you are looking for venture capital/equity investors.

There is no shortage of advice for Herman, but the adviser needs to understand the client’s real-life operation under a given structure. It’s no use telling Mel to be a corporation if she will not deal with paying herself a formal salary — she’ll end up abusing the structure and making things more complicated and expensive.  It won’t help Herman to be an LLC if he co-mingles his personal and business assets and expenses — sorry, all those checks for Junior’s private school you paid  out of the business account are strong weapons for an aggrieved party to sue and “pierce the corporate shield”. In other words, the corporate protection you have invested in may not hold up if you use it improperly.Choosing the wrong structure can set you back. Triple H, whose business structure I had to unwind, has $10,000 of annual income and one owner.  Established as a corporation, he should have been  on salary but was not advised of that. Actually, it would have been far simpler for him to be an LLC. It’s best to understand the implications of each form of ownership before you dive in.

NOTE: Every situation is different and federal and state tax laws are subject to change.  This article is presented exclusively for informational purposes and is not intended to substitute for obtaining tax or financial advice from a tax or other business professional. Names may have been changed for illustration purposes.

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