Sole Proprietor, LLC, Corp?

[bostonremodel]

Hi Guys, I am in my 3rd year of business, and have an annual volume of $500k. The business is still set up as a sole proprietor, and I was looking for some thoughts on the pros and cons of an LLC or Corp. I have heard different things about the true liability protection that these formats create.
Thanks, Mike

[mike maines]

Mike, I am far from an expert, but my understanding is that either an LLC or a corporation will give you protection from liability. The differences (LLC, S-corp, C-corp) have more to do with tax benefits (flow-thru vs. corporate tax) and how you can set up different owners. Have you talked with a lawyer or are you doing this on your own? NOLO press has some good books on this.

[Allan Edwards]

I also think there are less formal meeting requirements and documentation of meetings with an LLC.

[Dick Seibert]

Check your license laws, California didn't allow contractors to be LLCs until the first of this month, a new law now allows them, but with an added $100,000 bond and $1 million insurance requirement (California still doesn't mandate liability insurance for sole proprietors or corporations stating that all insurers threatened to pull out of state if they do).

Also check with your CPA, if you are a sub-chapter S corporation your corporation has to pay you a regular salary based upon the average salary of the president of a construction corporation doing your volume in your area. My accountant tells me that I've got to pay myself $10,000 a month minimum, so the first month of the year I'll be paying full FICA, unemployment, and disability insurance. I remember last year it cost my corporation $12,000 to pay me $10,000 and I netted $6,000 (in round numbers), so it cost me $6,000 a month to net myself $6,000. My accountant says it will all work out in the end, except for the fact that I'm paying into unemployment and disability insurance that I would never use. As I recall unemployment drops out after the first $7,000 so that applies only to the first month, disability at $96,000 so that drops out sometime in October, and FICA at $107,000 so that drops out in November (I think they raised that to $110,000 this year).

[Joe Adams]

Mike,

This is a question most of us have faced with establishing our own businesses. Unfortunately, there are no easy answers as both tax and tort laws vary from state to state.

There are four main issues to consider when choosing a business form.

1) Tax Implications
2) Personal Liability
3) Costs to Establish & Maintain
4) Complexity to Establish & Maintain

Obviously, Sole Proprietorships are inexpensive to start and easy to maintain but they offer few tax advantages and zero personal liability protection. LLC's and Sub-S Corps may offer you some tax savings as well as limit your liability but they take far more effort to establish and maintain.

You should know that as a one man shop, most creditors will still require you to personally guarantee any debt which negates the liability protection of your personal assets if you default. Your personal assets may also be vulnerable to lawsuits if the plaintiffs can get the corporate shield lifted by showing you intermingled personal & business funds or failed to keep proper records and make required filings.

You need to consider the pros and cons of each business form carefully and determine what is right for you. Do you have a CPA or attorney who can advise you?

[worthy]

As Dick Siebert suggests, there can be a lot of variation between jurisdictions.

For me, there have been tremendous income splitting and other tax benefits from operating as a corporation. See a CPA in your jurisdiction for details. And though it's an intangible--and I may be wrong--I think you make a better impression with "Inc." or "LLC"." after your company name. Certainly better than the scraps with phone numbers torn off corners of envelopes and cigarette packs that some contractors I know use as business cards.

[Joe Adams]

Also check with your CPA, if you are a sub-chapter S corporation your corporation has to pay you a regular salary based upon the average salary of the president of a construction corporation doing your volume in your area. My accountant tells me that I've got to pay myself $10,000 a month minimum...

Dick,

I'm sure your accountant is giving you good advice for your situation but it's not entirely correct for everyone. The tax law states the salary for an owner/officer of a Sub-S must be reasonable compensation for services rendered to the corporation.

The IRS has addressed this issue in a tax bulletin from which I have quoted below:
http://www.irs.gov/newsroom/article/...200293,00.html

There are no specific guidelines for reasonable compensation in the Code or the Regulations. The various courts that have ruled on this issue have based their determinations on the facts and circumstances of each case.

Some factors considered by the courts in determining reasonable compensation:

Training and experience
Duties and responsibilities
Time and effort devoted to the business
Dividend history
Payments to non-shareholder employees
Timing and manner of paying bonuses to key people
What comparable businesses pay for similar services
Compensation agreements
The use of a formula to determine compensation

The growth stage of your business (startup vs established) as well as the local economic conditions also have to be factored into what is reasonable.

One of the tax benefits of a Sub-S is the ability to take the minimum reasonable salary for your circumstances on which you pay employment taxes and then have company's profits flow through to you at the end of the year on which you pay only income tax.

[Albion]

Congratulations on your business success. Have you spent a few hours with a financial advisor yet? Fee only an hour a month an your likely to become better off then your wildest dreams. Heck even one hour a year an your way above the norm. Great time to consult with one an ask for their advise. How to find a good one? Ask your accountant or attorney or other contractors for a referral.

[Dick Seibert]

Joe:

Thanks for that link. I'm meeting with my CPA tomorrow for taxes and I also have her send out my 1099s. I've printed it out and am going to bring it with me, I absolutely hate paying things like disability and unemployment insurance on myself. I understand that in the end I'll have to pay all the FICA and taxes (even though at my age I both collect and pay FICA taxes), but those two get me mad.

BTW, after what Allan said once about paying himself I brought this up to her, her response was he's in Texas and you're in California, so this will help.

[Dick Seibert]

Joe:

This is specific to California and there are not that many of us here so I didn't start a new thread on it, but this is an E-mail I got from my CPA the other day.

When you do the downloads the additional $21 payroll tax should get picked up in your checking account. The tax is an additional tax that surprised all small businesses. This is what I wrote to another client yesterday that was asking about the tax.

Federal Unemployment is .8% of $7,000 or $56 normally. But actually the Federal unemployment rate is higher than .8% if you do not pay state unemployment. The real rate is 6.2% of $7,000. But because most of us also pay state unemployment, we receive a "credit reduction" of 5.4%. We never see the rate without the reduction. So most of us just think of .8% as the rate.

The State of CA borrowed money from the federal government to pay our high unemployment costs. Because CA couldn't pay that money back, the federal government is charging a "credit reduction". So our 5.4% credit reduction is now 5.1% leaving the rate most people pay 1.10%. This feels very much like a tax increase to me of $21 per employee. I am not sure how they can do this retroactively to employers in 2011. I just heard about it at the end of December. Imagine if you had 200 employees and you just now are learning you owe $4,200!!! This happened so late in the year Quickbooks didn't even have time to calculate it and record it on the payroll reports.

By the way, I have heard that CA owes a lot of this money back to the federal government, the .3 could double to .6 in 2012. In my mind this is a unfair tax increase on small businesses.

[bostonremodel]

Thanks for all the input. I will be discussing my options with my CPA as we do this years taxes.