Prepare, prepare, prepare. As a recession is bearing down on us all, figuring out how to prepare for economic downturns is something you should be concerned with in your DC Metro business. I know I am.
Now, while you and I can’t prepare for every eventuality, we can put systems and plans in place that will help our businesses face the most difficult ones. Like what I’m talking about today… taking a close look at your business structure and seeing if making a change would save you money in the long run.
As one example – are you prepared for the possibility of a natural disaster striking your area? Depending on what you do, that can have catastrophic effects on your business. You can come up with a plan. The Small Business Readiness for Resiliency program is a good resource to get you started.
And of course, I’ve been sharing my tips and strategies over the last couple of months in my inflation series, to help you make plans for an even thinner “economic winter.”
We can help you prepare in other ways. Starting with your tax situation. There are things you can do now – moves you can (and should) make – to help you save money and get all the deductions you are eligible for in your business. Use this right here (sooner is better than later).
Now for the final installment of my inflation series…
Changing Your DC Metro Business Structure – A Savings Opportunity?
“Change before you have to.” – Jack Welch
How you organize your operations makes a big difference to your bottom line. The same holds true about structuring your DC Metro business. You may have different reasons for changing your company structure, such as an expansion of personnel, products, funding; profitability; or asset protection.
This week our inflation series wraps up with a broad overview of the financial aspects of business entities.
Business structure types
One of the first and more variable expenses for a business entity is taxes. Yet the same complex taxes that can save a company and its owner money can also mean more expensive tax prep and setting up your new business structure. On the other hand, the more complex the structure the greater your personal protection against business debt.
Here’s a look at some of the most common entity types and their expenses and potential savings.
Sole Proprietorship. This may be your best path if you like doing most of the work, taking all the chances, and reaping the rewards. This is also the most common type of business entity – almost 30 million of them in the U.S.
Sole proprietors are liable for the company’s liabilities, debt and losses – your personal assets are on the line. You pay the taxes of the company, often through quarterly self-employment tax; your income is also taxed.
These entities are cheap (if not free) to form but obtaining future capital to expand can be harder than with other business structures.
Partnership. You own and operate the business with at least one other person.
There are general partnerships where the company is owned by two or more individuals who run it as partners or co-owners; limited partnerships with at least one general and one limited partner; limited liability partnerships where owners aren’t held personally responsible for the debts or other partners’ actions; and LLC partnerships that can have two or more owners, who are called members and whose personal assets are protected.
Your personal financial liability is diffused; so are your profits. Partnerships must file an annual information return to report the income, deductions, gains, losses, and so on from operations but they don’t pay income tax.
Many in partnerships and other entities can take a 20% tax deduction on their “qualified business income” (QBI) – check with us on this, though, as there are a lot of rules.
Limited Liability Corporation (LLC). An LLC exists as a separate legal entity that protects its members from personal liability for business doings.
Registration costs are generally in the low to mid-three figures, depending on your state. Services are available for you to set up an LLC, too, which are usually quick and reasonably priced. Raising capital can take more work, time, and money than with other entities.
For taxes, a domestic LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and elects to be treated as a corporation.
Corporation and S corp. Money and tax considerations get more complex with these entities. (We’re happy to advise further – give us a buzz.)
A corporation is a separate taxpaying entity that can elect to be taxed as a pass-through entity – a “subchapter S election” that requires filing an IRS Form 2553. Other conditions include a limit on the number of shareholders.
S corps pass corporate income, losses, deductions, and credits through to shareholders, who report the “flow-through” of income and losses on their personal tax returns. They also have to pay FICA taxes on salary compensation to owners and not on the remaining profits.
The IRS stresses that S corp owner-employees must be paid “reasonable compensation” for their services. Some states also have special rules for S corps.
C corp. Your corporation can also elect to be a C corporation. The owners are taxed only on the amount of earnings they receive as dividends — not the earnings the corporation retains. Owners can sometimes even get out of capital gains taxes when they sell certain stock of the company (on this and all tax matters, check with us).
C corps can be yet another structure to protect assets – and attract investors as well as live under a lower tax rate than S corps. Nevertheless, a recent study found that some startup C corps would have saved money if they’d formed as LLCs.
In a C corp, the company itself is taxed on income and any additional profits left over and distributed to shareholders (usually as dividends) are then subject to personal income tax. With C corps, planning with us is especially key to avoiding double taxation and other money drains. It can be a VERY appealing structure for certain kinds of businesses, because there is a flat taxation rate, and it isn’t as high as ordinary income.
But it depends on a few things to be “just right” … or it could make things worse.
No, nothing’s simple in business, but we can help with this and all your business questions.
We’re here for you in these difficult times.
On your team,
Cohen CPA Strategies LLC