Author Topic: How to structure new business  (Read 2672 times)

LiseE

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How to structure new business
« on: August 28, 2019, 08:27:23 AM »
Hi all ...  after 20+ years in the corporate world I was offered the opportunity to take a retirement package (which I was holding out for!) and now will be free to finally focus on my hearts desire .. to have my own business. 

I have looked at many passive income ideas and will probably try them all (more than once!) .. but wondering how to structure a business model?  If I start an LLC, can I do consulting work under it AND run my digital businesses out of it?  How does that work?  Can you point me to a good resource to learn more about it?

Thx
Lisa

CowboyAndIndian

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Re: How to structure new business
« Reply #1 on: August 28, 2019, 09:34:17 AM »
I ran a one-person consulting firm for many years with the only employee being me. I am not a CPA but a software engineer. I found that an LLC had far less paperwork/year compared to the S-Corp that I ran before. No quarterly filings, you file with your income taxes, etc.  So, I would see if you can use an LLC before deciding on an S-Corp or a C-Corp.

Yes, you should be able to do consulting and digital business under the cover of an LLC.

As far as resources go, I would recommend Nolo books (https://store.nolo.com/products/llc-or-corporation-chent.html), but get a qualified CPA to review your plans.

There are some great folks on this forum who can help you. @seattlecyclone  this seems like right up your alley.
« Last Edit: August 28, 2019, 09:37:36 AM by CowboyAndIndian »

seattlecyclone

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Re: How to structure new business
« Reply #2 on: August 28, 2019, 10:50:11 AM »
I'm also a software developer, at least a retired one. :-)

I think an LLC is generally a fine option for a small business. Or if it's a really small one where you're not taking out any debt or exposing yourself to any real risk of being sued, you might just opt for a sole proprietorship and avoid whatever fees and other formalities go along with maintaining an LLC in your state.

But yes, do talk to someone who knows more about what they're talking about than I do.

Smokystache

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Re: How to structure new business
« Reply #3 on: September 09, 2020, 07:39:59 PM »
Maybe I'm a moron, but I've providing consulting, training, products, services, digital services, digital products and more for 5+ years all with a sole-proprietorship. Could I have been sued? I guess so. But especially not knowing which of your business ideas will pan out, I wonder if this is worth much thought at all.

Just jump in to a business idea - it's easy to become an LLC after you have income, clients, and a more concrete idea of where you're headed. I've worked with almost 200 clients (businesses) and not a single one has asked me how I structured my business. The closest they have come is "who do I write the check to?" Best of luck on this new chapter!!

SeattleCPA

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Re: How to structure new business
« Reply #4 on: September 11, 2020, 07:02:28 AM »
@LiseE we used to sell them (mostly to attorneys?)... but we now in time of Covid-19 give away "do-it-yourself" LLC formation kits from our blog. You can probably even just follow the instructions for your state if you don't need the operating agreement included in the kit.

Here's where to find setup instructions and/or free downloadable kit for your state: https://evergreensmallbusiness.com/all-states-real-estate-investor-llc-formation-kit/

BTW, you probably would not want to use the Subchapter S (aka "S corporation") tax accounting approach the first partial year of operating... (The reasons why explained here: Should you use an S corporation for a part-time or sideline business.) If things ramp up in 2021 annd you're paying substantial self-employment taxes, that may be a different situation.

@Smokystache ? You probably want to look at the S corporation. That can be a big money saver. (The way you'd do this is set up an LLC now... and then elect S corporation tax treatment starting on January 1. (Logic explained here: The Million Dollar S Corporation Mistake.)

Smokystache

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Re: How to structure new business
« Reply #5 on: September 11, 2020, 09:29:14 AM »
...

@Smokystache ? You probably want to look at the S corporation. That can be a big money saver. (The way you'd do this is set up an LLC now... and then elect S corporation tax treatment starting on January 1. (Logic explained here: The Million Dollar S Corporation Mistake.)

You're absolutely correct. To be honest, this is the first year that I've been able to really scale my business where the S-Corp would be worth it, but I've followed your posts for a long time and I think my income is finally to the place to justify this. Thanks for all your posts and information about when (and when not) S-corps make sense. I may be contacting you for help with this.

SeattleCPA

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Re: How to structure new business
« Reply #6 on: September 11, 2020, 09:33:06 AM »
As long as you're working in a state where the LLC formation fees are reasonable, you may want to form an LLC now. (See those links to instructions and free kits.) And then, assuming things continue as planned in 2021, you maybe make 2553 election in early 2021.

BTW, the one state where the numbers get tricky: California. There you need to be able to save the 15.3% FICA tax in order to make the S corp gambit work well.

Good luck.

mrplutus

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Re: How to structure new business
« Reply #7 on: September 15, 2020, 09:35:59 AM »
Quote
If I start an LLC, can I do consulting work under it AND run my digital businesses out of it?

Since it sounds like you're materially participating in either case, all income from your business will be considered "earned".  If you run 1 or 2 companies, I don't see how you get out of paying SECA/Self Employment taxes on both of these sources of income.

Asset protection aside (still important), it seems better from tax perspective to just have one company.  It's more straight forward when you hit a critical mass of compensation in your state to implement the S Corp/LLC.  I say "state" here because the S Corp's tax savings vary massively from state to state.

I've built a S Corp tax savings calculator that reveals all state level taxes, which make or break the S Corp tax strategy.  If you're only looking at your Federal tax savings, you're taking a leap of faith.

That said I'm not a CPA, absolutely speak with one before making any big changes to your business.  Hope that helps!

SeattleCPA

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Re: How to structure new business
« Reply #8 on: September 15, 2020, 10:36:21 AM »
... reveals all state level taxes, which make or break the S Corp tax strategy.  If you're only looking at your Federal tax savings, you're taking a leap of faith.

That said I'm not a CPA, absolutely speak with one before making any big changes to your business.  Hope that helps!

I think I disagree with emphasis on state (or local) taxes. It's usually, in my experience, the payroll taxes and the Section 199A deduction that determine the financial benefit.

That's not to say that state taxes aren't important. They are. E.g., California. But most often, they aren't the big issue in my experience.

mrplutus

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Re: How to structure new business
« Reply #9 on: September 16, 2020, 10:05:00 AM »
Quote
I think I disagree with emphasis on state (or local) taxes. It's usually, in my experience, the payroll taxes and the Section 199A deduction that determine the financial benefit.

Thank you for your helpful feedback!  I didn't mean to imply that state taxes are the major concern, only that it is a necessary part of due diligence when considering the S Corp.  Thank you for your point on 199A; you're adding some much needed perspective here.
 
While what I was mentioning is for most a minor concern, in some states it has more weight like: Tennessee, Louisiana, New Hampshire, and as you mentioned California. In these states there's often taxes business owners don't know about, that need to be considered.  While no tool that estimates taxes can touch working with a CPA, my hope is at least it helps business owners visualize and prioritize the due diligence of choosing an S Corp.

Smokystache

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Re: How to structure new business
« Reply #10 on: September 16, 2020, 12:28:36 PM »
I should probably start a new thread, but several helpful and relevant comments are here for reference. I've been seriously considering transitioning from an sole-proprietorship to an LLC electing to be taxed as an S-Corp. The math seems to be fairly straightforward: if your profits are significantly higher than "reasonable compensation" then you can save significantly on your self-employment tax as long as you are willing to follow proper accounting, payroll, and reporting procedures.

However, I live in Tennessee and it appears that the Franchise and Excise Tax really throws a wrench in things (as a sole proprietor, I've never been aware of these before and may be misinterpreting them). In fact if my assumptions are correct, @mrplutus calculator suggests that it is very difficult for me to come out ahead as an LLC+S-corp in TN at almost any level of profit. Which suggests that if I want to avoid my state's excise & franchise tax I should continue as a sole-proprietor (recognizing that I'm giving up the limited liability protections that an LLC provides).

Am I missing something?

Lets use these as our starting assumptions:
- I would be a single member S Corp
- net profits would be 140,000/year; research suggests that paying myself $60,000 per year is a reasonable salary for my activities
- 95% of sales are services/5% physical products (if this matters)
- 90% of sales are to businesses outside the state of TN (if this matters)

Would it be worthwhile for me to transition to an LLC+S Corp?

SeattleCPA

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Re: How to structure new business
« Reply #11 on: September 16, 2020, 01:23:40 PM »
Quote
I think I disagree with emphasis on state (or local) taxes. It's usually, in my experience, the payroll taxes and the Section 199A deduction that determine the financial benefit.

Thank you for your helpful feedback!  I didn't mean to imply that state taxes are the major concern, only that it is a necessary part of due diligence when considering the S Corp.  Thank you for your point on 199A; you're adding some much needed perspective here.
 
While what I was mentioning is for most a minor concern, in some states it has more weight like: Tennessee, Louisiana, New Hampshire, and as you mentioned California. In these states there's often taxes business owners don't know about, that need to be considered.  While no tool that estimates taxes can touch working with a CPA, my hope is at least it helps business owners visualize and prioritize the due diligence of choosing an S Corp.

I agree with your points here.

SeattleCPA

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Re: How to structure new business
« Reply #12 on: September 16, 2020, 01:41:22 PM »
I should probably start a new thread, but several helpful and relevant comments are here for reference. I've been seriously considering transitioning from an sole-proprietorship to an LLC electing to be taxed as an S-Corp. The math seems to be fairly straightforward: if your profits are significantly higher than "reasonable compensation" then you can save significantly on your self-employment tax as long as you are willing to follow proper accounting, payroll, and reporting procedures.

However, I live in Tennessee and it appears that the Franchise and Excise Tax really throws a wrench in things (as a sole proprietor, I've never been aware of these before and may be misinterpreting them). In fact if my assumptions are correct, @mrplutus calculator suggests that it is very difficult for me to come out ahead as an LLC+S-corp in TN at almost any level of profit. Which suggests that if I want to avoid my state's excise & franchise tax I should continue as a sole-proprietor (recognizing that I'm giving up the limited liability protections that an LLC provides).

Am I missing something?

Lets use these as our starting assumptions:
- I would be a single member S Corp
- net profits would be 140,000/year; research suggests that paying myself $60,000 per year is a reasonable salary for my activities
- 95% of sales are services/5% physical products (if this matters)
- 90% of sales are to businesses outside the state of TN (if this matters)

Would it be worthwhile for me to transition to an LLC+S Corp?

As you suspect, probably not enough given the hassle factor...

Very rough numbers... say you do an employer SEP or 401(k) 25% match, or $15K, on the $60K... that means you have $65K left over.

You pay, I think, 6.5% corporate income tax on that $65,000. That costs you about $4K.

Assume you also pay $2K in state and federal payroll taxes.

Say your S corporation tax return and payroll service costs you $1K a year.

So all in, to play the S corporation game, you're at close to $7K. And it could easily be $8K a year.

Your S corp saves you about $10K in payroll taxes as compared to operating as a sole proprietor or an LLC taxed as a sole proprietorship.

So you're "up" about $2K to $3K... (The $10K of S corp savings minus $7K to $8K of extra costs.)

But I bet you also lose some Section 199A tax savings via the S corporation. Typically you would. (For an S corporation, the 20 percent 199A deduction only looks at the $65K S corp profit while for a sole proprietorship, the 199A formula would "see" maybe $115K of Schedule C profits. Roughly.)

So that doesn't seem worth it to me.

BTW, if some local to Tennessee CPA chimes in, pay attention to their local knowledge. They'll be much better at guessing at payroll tax and tax prep fees than I will. (We have tennessee clients but not any S corporations operating just in the state.)

P.S. In a more small business friendly state, the S corporation that looks like @Smokystache 's situation would avoid maybe $6K of payroll taxes and corporation income taxes. And now the thing is saving $8K to $9K a year... and that'll really add up over time.

Smokystache

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Re: How to structure new business
« Reply #13 on: September 17, 2020, 09:26:24 AM »
I should probably start a new thread, but several helpful and relevant comments are here for reference. ...

Would it be worthwhile for me to transition to an LLC+S Corp?

As you suspect, probably not enough given the hassle factor...

Very rough numbers... say you do an employer SEP or 401(k) 25% match, or $15K, on the $60K... that means you have $65K left over.

You pay, I think, 6.5% corporate income tax on that $65,000. That costs you about $4K.

Assume you also pay $2K in state and federal payroll taxes.

Say your S corporation tax return and payroll service costs you $1K a year.

So all in, to play the S corporation game, you're at close to $7K. And it could easily be $8K a year.

Your S corp saves you about $10K in payroll taxes as compared to operating as a sole proprietor or an LLC taxed as a sole proprietorship.

So you're "up" about $2K to $3K... (The $10K of S corp savings minus $7K to $8K of extra costs.)

But I bet you also lose some Section 199A tax savings via the S corporation. Typically you would. (For an S corporation, the 20 percent 199A deduction only looks at the $65K S corp profit while for a sole proprietorship, the 199A formula would "see" maybe $115K of Schedule C profits. Roughly.)

So that doesn't seem worth it to me.

BTW, if some local to Tennessee CPA chimes in, pay attention to their local knowledge. They'll be much better at guessing at payroll tax and tax prep fees than I will. (We have tennessee clients but not any S corporations operating just in the state.)

P.S. In a more small business friendly state, the S corporation that looks like @Smokystache 's situation would avoid maybe $6K of payroll taxes and corporation income taxes. And now the thing is saving $8K to $9K a year... and that'll really add up over time.

@SeattleCPA I really appreciate your analysis on this. Thanks so much!

FatFI2025

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Re: How to structure new business
« Reply #14 on: September 26, 2020, 04:58:34 PM »
Don't overthink it and just go with a single LLC. As your business grows you can mess around with more complex structures, but your primary focus should be getting revenue. I have several friends that have an active LLC but no revenue. And they're in California so they're paying $800/yr for a dream. It's so easy to file LLC paperwork, but hard to actually get business.

I only established an LLC in CA when I was signing a major customer. It's easy and takes just a few days.

@SeattleCPA mentioned LLC with S-Corp election. That's probably a good call, but know that you can only change your tax election once every five years, so make sure it's right for you long term.

SeattleCPA

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Re: How to structure new business
« Reply #15 on: September 29, 2020, 02:32:40 PM »
Don't overthink it and just go with a single LLC. As your business grows you can mess around with more complex structures, but your primary focus should be getting revenue. I have several friends that have an active LLC but no revenue. And they're in California so they're paying $800/yr for a dream. It's so easy to file LLC paperwork, but hard to actually get business.

I only established an LLC in CA when I was signing a major customer. It's easy and takes just a few days.

@SeattleCPA mentioned LLC with S-Corp election. That's probably a good call, but know that you can only change your tax election once every five years, so make sure it's right for you long term.

You can undo an S election pretty easily. It's not five years. But I still wouldn't "do" it if you're only going to need for a year or two... Too much hassle unless you've saving TONs....

FatFI2025

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Re: How to structure new business
« Reply #16 on: October 01, 2020, 10:08:24 PM »
Don't overthink it and just go with a single LLC. As your business grows you can mess around with more complex structures, but your primary focus should be getting revenue. I have several friends that have an active LLC but no revenue. And they're in California so they're paying $800/yr for a dream. It's so easy to file LLC paperwork, but hard to actually get business.

I only established an LLC in CA when I was signing a major customer. It's easy and takes just a few days.

@SeattleCPA mentioned LLC with S-Corp election. That's probably a good call, but know that you can only change your tax election once every five years, so make sure it's right for you long term.

You can undo an S election pretty easily. It's not five years. But I still wouldn't "do" it if you're only going to need for a year or two... Too much hassle unless you've saving TONs....

Oh my bad, I'm not a CPA admittedly. I was just thinking of Form 8832 where it says "Once an eligible entity makes an election to change its classification, the entity generally cannot change its classification by election again during the 60 months after the effective date of the election."

SeattleCPA

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Re: How to structure new business
« Reply #17 on: October 04, 2020, 07:58:28 AM »
No one should consider what I'm about to write a definitive treatment of all of the issues related to five year waiting periods and S corporations... but here's a quick summary.

First, the five-year waiting period for a entity classification change matters. But it's subtle. When an LLC elects to be treated as an S corporation, two elections actually occur. There's a deemed entity classification election that turns the LLC into a corporation. (You used to have to file a form 8832 and do this "manually" but not for a long time.) And then there's the actual S election which turns the corporation into a small business corporation, aka, an "S corporation."

There is a five-year waiting period for the first election, the entity classification election. (Source: https://www.law.cornell.edu/cfr/text/26/301.7701-3 ) Note, however, that one could either intentionally or unintentionally terminate the S corporation... and so undo the second election. That would leave the business owner with a regular corporation, aka a "C corporation." Also note that if the business owner dissolves the LLC, that puts them back into the sole proprietor category.

So bottom line: One can undo an S election.

Kind of related to this: If an S corporation terminates its S corporation status, Section 1362(d) says the entity needs to wait five years before re-electing. (Source: https://www.law.cornell.edu/uscode/text/26/1362 )

Final comment: You typically don't want to set up an S corporation if you'll use it only for a year or two. Too much work!


FatFI2025

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Re: How to structure new business
« Reply #18 on: October 06, 2020, 07:51:53 AM »
No one should consider what I'm about to write a definitive treatment of all of the issues related to five year waiting periods and S corporations... but here's a quick summary.

First, the five-year waiting period for a entity classification change matters. But it's subtle. When an LLC elects to be treated as an S corporation, two elections actually occur. There's a deemed entity classification election that turns the LLC into a corporation. (You used to have to file a form 8832 and do this "manually" but not for a long time.) And then there's the actual S election which turns the corporation into a small business corporation, aka, an "S corporation."

There is a five-year waiting period for the first election, the entity classification election. (Source: https://www.law.cornell.edu/cfr/text/26/301.7701-3 ) Note, however, that one could either intentionally or unintentionally terminate the S corporation... and so undo the second election. That would leave the business owner with a regular corporation, aka a "C corporation." Also note that if the business owner dissolves the LLC, that puts them back into the sole proprietor category.

So bottom line: One can undo an S election.

Kind of related to this: If an S corporation terminates its S corporation status, Section 1362(d) says the entity needs to wait five years before re-electing. (Source: https://www.law.cornell.edu/uscode/text/26/1362 )

Final comment: You typically don't want to set up an S corporation if you'll use it only for a year or two. Too much work!

Appreciate the clarification! This actually applies to some decision making I have coming up.

OP I hope this was valuable and didn't cause confusion by getting too in-the-weeds!