Author Topic: Best structure for a very small business?  (Read 394 times)

fallstoclimb

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Best structure for a very small business?
« on: August 11, 2017, 02:32:46 PM »
I've done some reading online but am getting somewhat overwhelmed and could really use some advice on this one!  Basically, I am trying to game my husband's very small business to be as tax-efficient as possible.

My husband has started a maker-based (think crafts) side business.  For now, sales are very low -- less than $1K this year, probably.  The dream is that in a few years this will allow him to drop back to part-time in his day job, and eventually will supplement our early retirement, but for now he's just getting off the ground and learning the skills.  He will likely never hire any employees, and we're not in a position where we need more retirement savings space.  He won't be taking loans or selling shares.

We want to formally register the business with our state (MD), primarily because we have a bunch of potential write offs: materials, product donation to a nonprofit, insurance, and we are eligible for the home office deduction which in itself should offset the cost of filing. 

Some more details that may be relevant:  We are in the 25% tax bracket, and we are also in the first year of owning a rental property (so are not sure the effect that will have on our taxes this year, although it is certainly operating at a loss after a month of vacancy).

The SBA has a helpful table on this website, but I don't really understand the different tax implications: https://www.sba.gov/business-guide/launch/choose-business-structure-types-chart.  I'm less worried about insurance as we do plan to purchase that regardless (his product could theoretically result in personal injury if it fails, so better safe than sorry).  I'm starting to lean towards a sole proprietorship, but want to make sure this is the right call. 

I have a few specific questions I'm trying to figure out:

1) Does a sole proprietor have the same available write offs as an LLC, in our scenario?  Or can an LLC take advantage of more tax write-offs? 

2) My thinking is that a C-corp wouldn't be worth it (at least at this juncture) because his profits are so low, so the actual taxes he is paying on the business are negligible, but is this correct? 

3) If we do an LLC over a sole proprietor and have to pay FICA taxes, will that suck or will we be tied to profit and therefore minimal?

4) If we do a sole proprietorship, can liability insurance make up for the personal asset risk we'll be taking?  I'm really only concerned about being sued if a product fails and causes harm (again, not really likely at all, would require kind of an insane perfect storm of events for this to happen, but still better safe than sorry).

5) Once we select a structure, are we tied into it forever, or can we change it at any yearly filing?

6) We can't even figure out if we need to be charging sales tax for his products.  I assume the answer is yes, but I am not clear on if him operating out of our home counts as a "physical presence" in the state - or if claiming the home office deduction would change this?

7) If he does need to be charging sales tax (which probably yes he does), is there any requirement to keep the money separate (like you would with a security deposit) or can you just take all the money your customers give you and then just pay the quarterly taxes out of your general account?

8) Lastly, if he sells online to someone out of state, does he charge them MD sales tax?

I know that filing quarterly taxes are a thing, but I'm not going to worry about that until we figure out these other questions.

dleavitt

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Re: Best structure for a very small business?
« Reply #1 on: August 11, 2017, 03:41:04 PM »
I've done some reading online but am getting somewhat overwhelmed and could really use some advice on this one!  Basically, I am trying to game my husband's very small business to be as tax-efficient as possible.

My husband has started a maker-based (think crafts) side business.  For now, sales are very low -- less than $1K this year, probably.  The dream is that in a few years this will allow him to drop back to part-time in his day job, and eventually will supplement our early retirement, but for now he's just getting off the ground and learning the skills.  He will likely never hire any employees, and we're not in a position where we need more retirement savings space.  He won't be taking loans or selling shares.

We want to formally register the business with our state (MD), primarily because we have a bunch of potential write offs: materials, product donation to a nonprofit, insurance, and we are eligible for the home office deduction which in itself should offset the cost of filing. 

Some more details that may be relevant:  We are in the 25% tax bracket, and we are also in the first year of owning a rental property (so are not sure the effect that will have on our taxes this year, although it is certainly operating at a loss after a month of vacancy).

The SBA has a helpful table on this website, but I don't really understand the different tax implications: https://www.sba.gov/business-guide/launch/choose-business-structure-types-chart.  I'm less worried about insurance as we do plan to purchase that regardless (his product could theoretically result in personal injury if it fails, so better safe than sorry).  I'm starting to lean towards a sole proprietorship, but want to make sure this is the right call. 

I have a few specific questions I'm trying to figure out:

1) Does a sole proprietor have the same available write offs as an LLC, in our scenario?  Or can an LLC take advantage of more tax write-offs?  No difference.

2) My thinking is that a C-corp wouldn't be worth it (at least at this juncture) because his profits are so low, so the actual taxes he is paying on the business are negligible, but is this correct?  C-corporations aren't generally recommended for small operating entities due to double-taxation of income.  Many small businesses are S-Corporations,
 but at this point Sole Proprietor (or single-member LLC, which is taxed as a sole proprietor) is probably the most cost-effective tax structure


3) If we do an LLC over a sole proprietor and have to pay FICA taxes, will that suck or will we be tied to profit and therefore minimal? Sole proprietorships and LLCs are taxed exactly the same unless the LLC elects to be taxed as a Corporation.

4) If we do a sole proprietorship, can liability insurance make up for the personal asset risk we'll be taking?  I'm really only concerned about being sued if a product fails and causes harm (again, not really likely at all, would require kind of an insane perfect storm of events for this to happen, but still better safe than sorry). That's a legal question,
 rather than a tax one.  If they sue you for more than your coverage your personal assets could be at risk (depending on state law).


5) Once we select a structure, are we tied into it forever, or can we change it at any yearly filing? Generally yes.  The notable exception would be an LLC, which can start as a sole proprietorship or partnership (one versus multiple members), but elect later to be taxed as a C- or S-corporation.  C-Corporations can also elect to be taxed as S-Corporations if they have fewer than 100 shareholders and a calendar year end.

6) We can't even figure out if we need to be charging sales tax for his products.  I assume the answer is yes, but I am not clear on if him operating out of our home counts as a "physical presence" in the state - or if claiming the home office deduction would change this? Don't know on this won, no sales tax in Oregon so not as familiar with this area of tax.

7) If he does need to be charging sales tax (which probably yes he does), is there any requirement to keep the money separate (like you would with a security deposit) or can you just take all the money your customers give you and then just pay the quarterly taxes out of your general account?See above

8) Lastly, if he sells online to someone out of state, does he charge them MD sales tax?  See above

I know that filing quarterly taxes are a thing, but I'm not going to worry about that until we figure out these other questions.

fallstoclimb

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Re: Best structure for a very small business?
« Reply #2 on: August 12, 2017, 08:37:41 AM »
Thanks for the reply.  I'm still so torn on LLC or sole proprietorship - LLC filing fee in MD is more expensive (I believe sole proprietor is free, LLC is $300 annually) but it sounds like we'd be more protected with the LLC.  Any other thoughts on this one? 

fallstoclimb

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Re: Best structure for a very small business?
« Reply #3 on: August 12, 2017, 09:52:11 AM »
And, doing more reading on this -- a sole proprietor gets to claim business losses off their personal tax return.  This seems most advantageous to us, I would think.  But, I'm not sure how to weigh that benefit with the risk of personal liability.

Also, a friend has told me there is a difference between a legal status and a tax status, which is leading me to think -- is it possible to be a legal entity LLC and a tax entity sole proprietorship?  And therefore write off the business losses on our personal tax return?

http://www.mdsbdc.umd.edu/choose_your_business_entity_maryland_small_businesses_mdsbtdc.php

protostache

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Re: Best structure for a very small business?
« Reply #4 on: August 12, 2017, 06:43:02 PM »
And, doing more reading on this -- a sole proprietor gets to claim business losses off their personal tax return.  This seems most advantageous to us, I would think.  But, I'm not sure how to weigh that benefit with the risk of personal liability.

Also, a friend has told me there is a difference between a legal status and a tax status, which is leading me to think -- is it possible to be a legal entity LLC and a tax entity sole proprietorship?  And therefore write off the business losses on our personal tax return?

http://www.mdsbdc.umd.edu/choose_your_business_entity_maryland_small_businesses_mdsbtdc.php

The default for single member LLCs is to be disregarded by the IRS. You would file a Schedule C for your LLC on your personal tax return, exactly as if you were operating as a sole proprietorship.

I would strongly suggest sitting down with an attorney for an hour or two to talk about your options. Nobody here will be able to give you any kind of opinion on whether an LLC will provide the kind of legal protection you seem to think you need.

CareCPA

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Re: Best structure for a very small business?
« Reply #5 on: August 13, 2017, 07:38:14 PM »
And, doing more reading on this -- a sole proprietor gets to claim business losses off their personal tax return.  This seems most advantageous to us, I would think.  But, I'm not sure how to weigh that benefit with the risk of personal liability.

Also, a friend has told me there is a difference between a legal status and a tax status, which is leading me to think -- is it possible to be a legal entity LLC and a tax entity sole proprietorship?  And therefore write off the business losses on our personal tax return?

http://www.mdsbdc.umd.edu/choose_your_business_entity_maryland_small_businesses_mdsbtdc.php
I'm guessing, based on the fact that you started this thread in the first place, that you don't understand how the flow-through works from the different types of entities.
LLC losses will pass through to you, and as such will also offset your regular income (making the assumption that you are actively involved in the business and have basis). This assumes the LLC is taxed as a non-C-Corp separate entity (i.e. a partnership or S Corp).
As mentioned above, the default single-member-LLC classification is a sole proprietorship. It will show up on your Schedule C as if it didn't even exist.

From a purely tax perspective, there is really no benefit to even forming an LLC for income that low. I cannot speak to the legal protections.

As far as sales tax - you have a partner/employee in the state. In all states that I am aware of, that gives you physical presence. You would be responsible for collecting and remitting sales tax for sales to Maryland residents, assuming your product is subject to sales tax to start with. There is no need for a separate bank account that I am aware of.

No need to charge to out of state customer unless you have nexus in that state (i.e. you store things in a warehouse, have another employee, etc). States are getting very aggressive on this, so make sure you keep up to date on the rules.
Always happy to help with tax or accounting questions - feel free to private message me.

I am a licensed CPA in Pennsylvania. However, any tax advice I give should be considered general information and not used in the avoidance of tax. There is most likely information about your situation that I do not know, and thus you should do your own additional research.

Yes, in case it confuses you, I did change my forum name.

taxedatty

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Re: Best structure for a very small business?
« Reply #6 on: August 14, 2017, 07:04:13 PM »
"As far as sales tax - you have a partner/employee in the state. In all states that I am aware of, that gives you physical presence. You would be responsible for collecting and remitting sales tax for sales to Maryland residents, assuming your product is subject to sales tax to start with. There is no need for a separate bank account that I am aware of.

No need to charge to out of state customer unless you have nexus in that state (i.e. you store things in a warehouse, have another employee, etc). States are getting very aggressive on this, so make sure you keep up to date on the rules."

^^Solid advice. 

Additional food for thought: With respect to states other than MD, your presence does not need to be permanent in the form of an additional employee or partner to create taxable nexus -- even your husband going into another state to deliver a product to a customer or attend a craft show may create sufficient physical presence for sales and use tax nexus even if no sales are made as "regular" and "systematic" solicitation activities themselves are sufficient to create nexus.  For example, since you live in MD, it may be possible that your husband will attend craft shows in PA.  PA, provides specific guidance on this point at https://revenue-pa.custhelp.com/app/answers/detail/a_id/200/kw/sales%20tax%20nexus%20trade%20shows/session/L3RpbWUvMTUwMjc1NTI5Ny9zaWQvQTU3Vlc5cW4%3D.  I'm not suggesting you need to go out and register in a bunch of states at the moment, I just wanted to provide an example that may not be generally be intuitive so you have some ideas of what you should be thinking about.  So by extension, if your husband goes to a craftshow in PA and is therefore registered to collect and remit sales tax for PA, when he returns to MD and makes online sales to individuals in PA, even though the craft show is over, he will then be required to collect and remit PA sales tax since he created nexus in that state.

fallstoclimb

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Re: Best structure for a very small business?
« Reply #7 on: August 15, 2017, 03:23:01 PM »
This is really helpful, particularly about sales tax which we were clearly clueless about -- thanks!