The new year is a great time to consider forming a business… and go skiing
Each new year brings reflection. As a business owner or prospective business owner, you will think about the successes and lessons of the past year or reflect upon why you want to start a business. Hopefully you will continue any practices that led to your successes and learn from the lessons you learned. If you are forming a business, it’s an exciting time but also one to consider a lot of things. The new year often brings with it a time to sit down with a tax advisor determine and discuss any tax liability from the year before and the year to come. If you are in business and you have not formed a formal business entity to operate your business now is the best time to consider doing it for the year to come and the future.
Forming the Business
There are many types of business entities. In Washington state, the most common business structures are the sole proprietorship, a Limited Liability Company (aka LLC), a Corporation and a Partnership. Each has some advantages and disadvantages. In my opinion, the LLC is the best all-around structure to use.
When I was in college and law school I skied a lot at a resort called Alta. Alta gave us starving students the best bang for our buck because it had the best terrain and the most diverse slopes at the most affordable cost. This is why I like the LLC. Let me explain.
The Best Terrain.
The LLC is the newest legal entity of all of the aforementioned structures. The laws which started LLC’s are young, less than 30-50 years old in most states. On the other hand, corporations are like sharks and crocodiles, remnants of the dinosaur age. The laws that govern LLC’s are written with more than 100 years of hindsight. Legislators, lawyers, politicians, lobbyists and anyone else involved in the legislative process looked to the good, bad and ugly of corporations and partnerships and created the new and improved LLC statutes.
The Most Diverse Slopes.
The modern LLC is the most diverse and flexible legal entity known. Here in Washington for example, an LLC is not required to hold meetings or keep written documentation (aka minutes) of any meetings if the owners choose not to do so. On the other hand, a corporation is required to hold meetings and keep minutes of all meetings. In fact, there are decades of case law where a corporation has been “pierced” and an owner is held personally liable for corporate liabilities due to not holding required meetings and not keeping required minutes. With an LLC, since it is not required to hold meetings or keep minutes of any meetings, owners cannot be personally liable for failing to do these things.
For income tax purposes an LLC has maximum flexibility. An LLC is a creature created by state law. Federal income tax laws and regulations are created by the US Congress and the US Treasury. This can be confusing for some folks but stay with me. For state purposes, a person can form an LLC. Then, an LLC can choose any one of up to four federal tax treatments. This is where it gets great and the accountants and tax preparers love this. Here’s how it works.
An LLC’s owners can choose to be taxed as a sole proprietorship in the case of a single owner or a married couple in a community property state. This provides the benefit of the liability protection of an LLC for its owners. It also simplifies reporting all income and deductions on an owner’s personal IRS form 1040. This has the best of the liability protection and the least amount of hassles for federal income tax.
In the case of a single owner or multi-owner LLC, it can also choose to be treated as a partnership, S-Corporation or C-Corporation for federal income tax purposes. Each of these tax statuses has distinct advantages and disadvantages. One big consideration is the type of business you are in. For example, a real estate investor who buys and manages a portfolio of real estate will have different considerations than a business owner who manufactures and/or sells goods or a professional who provides services. Another consideration is how much income and expenses you have and which structure will be the most tax efficient. Finally, another big factor is whether one partner needs more income or deductions allocated to him or her for personal tax efficiency.
Generally, since corporations and partnerships are antiquated structures, they are more complicated to setup. Since they require many more formalities to maintain more time and attention is required to manage those details. Therefore, they are more expensive to properly form and maintain than an LLC. The actual cost of forming any legal entity depends on a number of factors. But generally, more time is necessary for a business entity with multiple non-married owners.
The specific pros and cons vary widely and should be discussed with your tax professional and a qualified attorney. This article is just general information and is the tip of the iceberg. Please contact my office if you would like to discuss a business formation.