Diane Kennedy
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- Aug 31, 2007
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I see some common questions coming up regarding the best business structures for investing and business. I thought it would be helpful to run through some of the basics for business structures.
There are good, bad and really bad business structures:
Good: LLC (limited liability companies), S Corporations, C Corporations, Limited Partnerships
Bad: Sole Proprietorships
Really Bad: General Partnerships
The good ones all provide some form of asset protection. I consider the Sole Proprietorship bad because it (1) puts all of your other assets at risk (2) costs you self-employment tax of 15.3% on taxable income and (3) means you are 10 times more likely to have an IRS audit.
As bad as Sole Proprietorships are, General Partnerships are even worse. You have all the risks above, but it's times two because you have a partner. So, you're not only liable for your decisions but those of your partner as well.
WARNING: If you and someone else go into a business venture without a business structure, you will be considered to have a General Partnership. Beware!
BUSINESS INCOME:
Of the good ones: LLC, LP, S Corp and C Corp, there are still more differences. An LLC can elect how it wants to be taxed. The default for a single member LLC is a Sole Prop (but with asset protection) and the defaul for a multi-member LLC is a partnership (but it's a good one because you have asset protection).
If you have a business, you are subject to self-employment tax UNLESS you elect to be taxed as an S Corp or a C Corp. Partnerships and LLCs (not electing S or C) with business income will be subject to self-employment tax.
For a beginning business: typically LLC taxed as an S Corp or an S Corp itself.
For a beginning business with partners: I like an LLC with the members holding their interest in S Corp or C Corp structures.
For a mid-level business: (Taxable income at approx $150K - $350K), it makes sense to either change your S Corp to a C Corp or add a C Corp to your business structure. A C Corp is the only structure that pays tax at its own level (LLC, LP, S Corp are all flow-through entities with the taxable income reported on your personal return). So, as your income increases, you can make use of the tax bracket of the C Corp and move $50K from your personal return to your C Corp and move from a 35% to 15%. That means $10,000 of tax savings right away.
REAL ESTATE PASSIVE INCOME:
If you hold property (as an investment), you do not have business income, so the self-employment tax is not an issue. Typically the default LLC structure is best for real estate ownership.
OTHER CONCERNS:
There are special rules on who can own an S Corporation - must be US residents, limited to 75 individual and other rules.
An S corp or a C corp protects you against judgements from the business in most cases, but does not protect the stock you hold in S Corp or C Corp from personal judgements. An LLC protects both your business assets from personal judgements as well as your personal assets from business judgements. (There are exceptions to this as well. This is a broad general statement.)
In general, I like to use an LLC electing to be taxed as an S or as an C, instead of just owning an S or C directly.
I thought it might be easier to put all the basics in one thread.
There are good, bad and really bad business structures:
Good: LLC (limited liability companies), S Corporations, C Corporations, Limited Partnerships
Bad: Sole Proprietorships
Really Bad: General Partnerships
The good ones all provide some form of asset protection. I consider the Sole Proprietorship bad because it (1) puts all of your other assets at risk (2) costs you self-employment tax of 15.3% on taxable income and (3) means you are 10 times more likely to have an IRS audit.
As bad as Sole Proprietorships are, General Partnerships are even worse. You have all the risks above, but it's times two because you have a partner. So, you're not only liable for your decisions but those of your partner as well.
WARNING: If you and someone else go into a business venture without a business structure, you will be considered to have a General Partnership. Beware!
BUSINESS INCOME:
Of the good ones: LLC, LP, S Corp and C Corp, there are still more differences. An LLC can elect how it wants to be taxed. The default for a single member LLC is a Sole Prop (but with asset protection) and the defaul for a multi-member LLC is a partnership (but it's a good one because you have asset protection).
If you have a business, you are subject to self-employment tax UNLESS you elect to be taxed as an S Corp or a C Corp. Partnerships and LLCs (not electing S or C) with business income will be subject to self-employment tax.
For a beginning business: typically LLC taxed as an S Corp or an S Corp itself.
For a beginning business with partners: I like an LLC with the members holding their interest in S Corp or C Corp structures.
For a mid-level business: (Taxable income at approx $150K - $350K), it makes sense to either change your S Corp to a C Corp or add a C Corp to your business structure. A C Corp is the only structure that pays tax at its own level (LLC, LP, S Corp are all flow-through entities with the taxable income reported on your personal return). So, as your income increases, you can make use of the tax bracket of the C Corp and move $50K from your personal return to your C Corp and move from a 35% to 15%. That means $10,000 of tax savings right away.
REAL ESTATE PASSIVE INCOME:
If you hold property (as an investment), you do not have business income, so the self-employment tax is not an issue. Typically the default LLC structure is best for real estate ownership.
OTHER CONCERNS:
There are special rules on who can own an S Corporation - must be US residents, limited to 75 individual and other rules.
An S corp or a C corp protects you against judgements from the business in most cases, but does not protect the stock you hold in S Corp or C Corp from personal judgements. An LLC protects both your business assets from personal judgements as well as your personal assets from business judgements. (There are exceptions to this as well. This is a broad general statement.)
In general, I like to use an LLC electing to be taxed as an S or as an C, instead of just owning an S or C directly.
I thought it might be easier to put all the basics in one thread.
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