Should you set up an LLC?

Out of all the questions I get asked as a CPA, one that comes up more than any other:

Should I open an LLC?

As always, the answer is, 'it depends.' What you decide will differ for who you are and where you live — amongst other variables.

The purpose of this question is often focused on asset protection, planning for Federal Income taxes and other tax structuring.

Business entity structuring can be used as a crutch to folks starting out. Like buying domain names, picking the perfect logo, or designing your future world headquarters, you might be getting ahead of yourself by worrying about this. You might do better to spend time finding your first customers.

Sometimes there is a chicken or the egg problem for bigger businesses or buying assets. You need all the corporate formality to make a start. Either way, once you are on a roll, it’s time to get organized!

Today, I will be focusing on three main entity types related to Federal Tax purposes:

• Disregarded Entities
• Pass Throughs
• C-Corporations

Disregarded Entities

This isn’t the hottest tax strategy you’ll hear about from the TikTok finance bros out there. Although disregarded entities are boring, they still have a purpose.

If you open up an LLC you own 100% of and make no tax elections, you own a disregarded entity.

This type of legal entity is disregarded by the IRS from filing for federal income tax purposes. You would file this activity wherever it would go on your return if there was no LLC.

Disregarded LLCs are typically used by those prioritizing privacy, asset protection, and probate avoidance, as they have no beneficial tax attributes.

Pass Throughs

Pass throughs can offer a bit more fun than disregarded entities.

It's worth mentioning there are many different types of entities that you can set up in each state including LLCs, LLPs, LPs, PCs, PLLCs, etc. Each of them is useful for different reasons and different legal characteristics apply to each, but at the end of the day, each defaults to pass through activity to your personal tax return.

From a tax perspective - your entity will be treated as one of the following:

• Partnerships: These carry the most flexibility out of all entities and are more often than not a part of a business entity’s structure in one way or another. An entity owned by 2 or more parties would default to a partnership. There can be general and limited liability partners, you can freely contribute and distribute property. You can also differentiate how losses, debt, income and distributions are allocated based on the partnership agreement, the formal organizing document for the entity.
• S-Corporations: An S-Corp is a small business entity where the LLC elects to be treated as an S-Corp by the IRS. At their best, S-Corps are asset-light businesses or consulting businesses with one or a handful of owners. They are not ideal for holding tons of assets, as they can take a few steps to unwind. We frequently see small business owners use S-Corps because it allows them to save big on payroll taxes - equal to 15.3% of their earnings. A very profitable S-Corp can optimize for a Qualified Business Income deduction which allows for a 20% deduction on business earnings, taking the owner from 37% marginal tax at the highest rate down to a ~30% effective rate. The typical Better Bookkeeping client is running a profitable, asset light business as an S-Corp, or has raised capital and is treated as a C-Corp.

C-Corporations

A C-corp files a return and pays tax, but is recognized as a separate tax-paying entity through its owner or shareholders. The corporation pays a fat 21% tax, but any dividends (profits paid out of the corporation to owners) are taxed again at 15-23.8% tax. Every single company in the United States that is publicly traded is a C-Corp. These companies endure past the life of the original owners.

A huge other advantage C-Corps offer is QSBS - the $10MM Qualified Small Business Stock Exemption on sale. That is another letter for another day!

Consider the following sources when setting up your business:

1. Your local business attorney - As there are so many types of entities as we've mentioned, it is important to get some set up and planning advice. Especially as the your needs get more specific and complex, there is no substitution for real hard earned advice.
2. ​Better Legal — a great online service to help you set up an LLC started by my friend Chad Sackonchick. They are low cost, fast, and don't sell you a bunch of junk that you don’t need or farm out your data like other “similar” services.

These entities do allow you to take advantage of some of the best breaks out there today, and create a container for you to run your business with legal liability protection. Remember to seek out help from a business attorney before you begin setting up your business to avoid any slowdowns, mistakes, and missed opportunities.

Until next time,

Mitchell

P.S. If you made it this far and enjoyed what you read, forward this to a friend who might like it! If you were sent this message sign up and read the back catalogue.

P.P.S. My friend Scott Hambrick and I have been working on a podcast! It’s called Stupid Tax - covering taxes, small businesses, and a whole lot more. This weeks' episode - Life is a funnel