LET’S TALK ABOUT YOUR LLC!!!
This past month I’ve been asked So. Many. Questions. And I’ve heard quite a few misconceptions about LLCs! I’m here to speak the truth and make this as simple as possible.
Misconception #1: An LLC will save you money on taxes. WRONG!!
Truth: An LLC is a state recognition that legally separates your personal assets from your business assets. It has zero effect on your taxes. Taxes depend on whether you are a sole proprietorship, partnership, S-corporation, C-corporation or non-profit.
This means if you are the sole owner of your business that was registered as an LLC with the state and no other action was taken, you are a sole proprietorship for tax purposes.
If there are two or more owners of your business, your business was registered as an LLC with the state, and no other action was taken, you are a partnership for tax purposes.
If you are a sole proprietorship or partnership and you would like to be taxed as an Scorporation, you need to file the appropriate paperwork with the IRS and register payroll accounts with your state.
It takes a little bit more work to set up an Scorp, but, keep on reading, because it has the potential to be extremely beneficial!
Misconception #2: Choosing a business entity is hard.
Truth: It’s only hard if you make it hard! Let me break it down for you…
Do you have personal assets you want to protect? If yes, then form an LLC.
Is there a high risk of someone getting hurt at your business location? If yes, form an LLC.
Does your business operate in an industry that is likely to be sued? If yes, form an LLC.
And, the catch all question: Is your business a hobby or a business? Because in my opinion, everyone operating as an intentional business should give themselves the protection of an LLC.
See, not too complicated, right?
But, what is a little complicated, is figuring out if you should be a sole proprietorship or an S-corporation. So, let’s chat more about that…
For the most part, those making (or who plan on making) annual net income of $80,000 or more will benefit from considering an S-corporation.
Why? Because ALL net income in a sole proprietorship is subject to self employment tax (15.3%) while only the payroll portion of an S-corporation is subject to self employment tax.
This means if you earn $100,000 in an S-Corp, pay yourself $40,000 through payroll and the remaining $60,00 is taken in distributions, you will wind up paying $6,120 in payroll taxes.
If you are operating as a sole proprietorship and earn the same amount ($100K annual profits), you will pay $15,300 in self employment taxes because you will pay self-employment taxes on the FULL amount of profits, not just the payroll portion.
If you did that math, you’d have noticed that an Scorporation would save a business owner approximately $9,180 of self-employment taxes BUT, here’s the kicker, there are other tax credits you need to consider. Surprise, surprise. Taxes aren’t straightforward. We need to take into consideration QBI (a tax deduction for small businesses), your reasonable compensation, and additional business expenses (like the cost of a payroll subscription or another tax return).
Since we’re dealing with taxes and it’s not always straightforward, we recommend working with a tax professional to help you make this decision.
We’ll help forecast your income and expenses, project your tax balances, perform a reasonable compensation analysis, and take your goals into consideration.
Misconception #3: An LLC acts as business insurance.
Truth: An LLC is a type of business entity recognized by your state. It acts as a veil or a shield of legal protection by separating your personal assets from your business assets and liabilities.
If you were sued *knock on wood* then your personal bank account, car, house, and other personal investments would be protected from this legal shield (assuming you are using your LLC correctly and not commingling accounts. Please keep your personal and business accounts separate!!!).
So where does business insurance come into play?
If you’re sued for something covered by your policy, business insurance will actually cover the costs for an attorney, going to court, settlement fees, etc.
Follow up question: do you need both?
Well, if you’re sued and don’t want to fork up the fees on your own, then yes!
The LLC protection and business insurance work hand in hand with each other to fully protect you and your business.
Misconception #4: You should wait to form an LLC until your business is making good money.
First off, what the heck is “good money”? Someone please define that for me! I swear I hear this term all the time and I’m like… What??? Because I’m pretty sure $1,000 to one person is not the same as $1,000 to another person.
Anyway… moving on.
I already addressed my beliefs on forming an LLC (refer to misconception #2) but if you need another reason to form an LLC, here’s this: you need to have your LLC established in order to setup your S Corporation!
Here’s how it works:
This means that legally you are still an LLC but tax wise, you are now an S-corporation.
So, putting it all together now…
What happens if you form a sole proprietorship, your business blows up, and now your annual profits are $200K for the year?
I’ll tell you what happens. First, you celebrate the heck out of that $200K!!! Next, you hire us to be your bookkeepers. Third, you find out that you have to pay a ton in taxes because you are a sole proprietorship.
On the other hand, what would happen if you formed an LLC, your business blows up, and now your annual profits are $200K for the year?
First, you’d celebrate the heck out of that $200K!!! Next, you’d hire us to be your bookkeepers. Third, we would help you file a late election S-corporation and you’d save thousands of dollars in taxes.
So, even if you don’t need the S-corporation right now, plan for the best and get that LLC setup just in case something magical happens.
Misconception #5: You don’t get to pay yourself as much money if you’re an S-Corporation owner.
Truth: As an S-Corp owner you’re required to pay yourself a “reasonable compensation”. This amount looks different for everyone. Usually, it’s somewhere in the $35,000-$90,000 range. BUT (here’s the kicker) you ALSO get to take distributions.
That’s right, the payroll you earn is not your only source of income.
Payroll is typically paid on a schedule and distributions are taken whenever they’re needed!
Plus, you are not required to pay self employment tax on distributions so you get to save money on taxes!
Does it make more sense now? You are NOT paying yourself less money. You’re just getting money from two different sources.
Doesn’t sound so bad after all, huh?
Are you eager to learn more about LLCs and S-corporations? Take our Ins and Outs of Tax For Entrepreneurs course!
Or, if you have a question about LLCs and entity business structures, please don’t hesitate to ask us! We’re here to help 🙂
P.s. Just a quick note about reasonable compensation:
We have all our clients complete a detailed questionnaire that takes into account where you live, how many hours you work each week, what jobs/tasks you manage, and your level of expertise. Because guess what? You’re not always working in your zone of genius! You’re also the social media manager, web developer, copywriter, accountant, IT consultant, HR coordinator, business strategist, receptionist, janitor, and so much more.
If you’re an S-Corp owner and either your or your accountant “just decided on an amount” – that’s wrong. You need backing and proof in the event of an audit. Please reach out to us so we can help you approach reasonable compensation in a more methodical way!