US-Based Taxes/Business Formation (CPA)

[CareCPA]

I've been waiting for this thread. Not sure how I missed it.

My question is similar to Blake's and you may have answered it in the other thread where I asked.

I set up my LLC through LegalZoom and they made it seem like I had to pick an S-Corp or C-Corp. I think I may have even been advised by a family member to register as an S-Corp. He worked in, started, and sold multiple businesses in the same line of work that I am doing so I trust him. I am a single-member LLC and funded the company originally through a new business checking account with my own money.

My thoughts right now are that the business expenses flow through to my personal income to help with tax deductions regarding expenses related to the business, including home office, vehicle maintenance, gas, food, utilities, etc. Does the S-Corp affect that in any way?

And I saw that you gave instructions how to stop the S-Corp. I think I received confirmation of the S-Corp around April of this year and have only made one sale as of August (assuming the product is accepted). My point is that I haven't done anything 'substantial' within the business at this point other than have expenses like I stated above. And, I am going to take a loss on the entire first contract that I won because I needed to buy shipping labels for the little boxes. So, should I consider calling the IRS and trying to cancel the S-Corp designation? I'm still not really sure what is going to change or how it will affect me being a single-member.

Thanks!

When you register an LLC, the default classification for a single-member LLC is a disregarded entity. This means that the activity from the LLC would show up on your Schedule C similar to a sole proprietorship. The default for a multi-member LLC is a partnership.
You can then elect to be taxed as a C Corp or an S Corp, but you aren't forced into those at any point.

Losses from the S Corp will show up on your individual return to the extent that you have basis in the company (i.e., money that you have put in or directly loaned to the company).

The downside that you're going to face is that in order to get money out of the S Corp (in excess of any bona fide loans that you put in), the IRS is going to expect you to take a reasonable W-2 wage before taking any distributions. The S Corp becomes extremely beneficial when your profit for the year exceeds your "reasonable salary," because you are then saving the 15.3% self-employment tax on those earnings.

 

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[CareCPA]

I've got another one. Have you ever read the book Profit First by Michealowicz, if so, do you think it's a viable accounting method or reckless?

I have not, but I've seen the methodology (did you mention it in another thread, perhaps?). I believe the philosophy is simply a "pay yourself first" mentality?

I guess my question would be: what are you doing with the profits that you take out first? Would that profit be better served reinvested in your business?

I think paying yourself first is great, if you only want to replace your job with a business that's essentially a job. But to create a company that you can separate from your time and reliance on you, there may be several years at the beginning where you don't get paid. It doesn't mean your expenses are magically expanding to match your revenue - it means you are strategically investing in your business to grow it into what you want it to be.

I'll check it out though, if you think it's worthwhile.

 

[CareCPA]

Are there any restrictions on registering LLCs out of state?
For example, I've seen a lot of people suggesting opening a Delaware LLC when you're dealing with selling digital products/SaaS/etc. What is the benefit? Can I open a Delaware LLC for ANY type of business? If not, what are the differences/restrictions?
Thanks in advance.

I'll take the easy one first: you can open a Delaware LLC (or an LLC in any state) for any type of business.

A lot of companies that register in Delaware are, or will be, C Corps. They're bringing in investors, etc that are looking for the corporate structure, not a passthrough structure. Delaware, of course, has a very business-friendly (and tax-friendly) environment.

From a tax perspective, there isn't a benefit to opening a Delaware LLC if you live in another state, because your home state is still going to tax you on that income. You're just adding an additional annual report to file and pay for. There may be benefits if you are living a digital-nomad type lifestyle out of the states. International taxation is not my current area of expertise

There are potential benefits to having entities outside your state for non-tax reasons. For example, some states have strong privacy regulations, so no one will be able to find out that you own the business. Some states may have a more business-friendly court system if your industry is risky and you can swing where conflicts will be resolved.

 

[CareCPA]

Given that the guys at Moss Adams charge $125/hr to answer these questions you're answering for free... it kinda feels like you brought this on yourself

Ha! Fair enough. Can't argue with that.

 

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[Aaron T]

I'll hit up my former business partner for half haha (the laughter is because he won't)

How many times this has happened to me. I can laugh with you on it. But I can also say most of my past partners that have pulled this kind of stunt on me are also sldewalkers and pretty much where they are as a result.

 

[InspireHD]

When you register an LLC, the default classification for a single-member LLC is a disregarded entity. This means that the activity from the LLC would show up on your Schedule C similar to a sole proprietorship. The default for a multi-member LLC is a partnership.
You can then elect to be taxed as a C Corp or an S Corp, but you aren't forced into those at any point.

Losses from the S Corp will show up on your individual return to the extent that you have basis in the company (i.e., money that you have put in or directly loaned to the company).

The downside that you're going to face is that in order to get money out of the S Corp (in excess of any bona fide loans that you put in), the IRS is going to expect you to take a reasonable W-2 wage before taking any distributions. The S Corp becomes extremely beneficial when your profit for the year exceeds your "reasonable salary," because you are then saving the 15.3% self-employment tax on those earnings.

Thank you! I appreciate you taking the time to reply.

From my understanding, everything should still be okay then? I know you can't give me any legal advice so I will make the decision, but would there be any recommendation to trying to stop the S-Corp or just let it go?

It sounds like there is some kind of benefit to it in the long run when profits begin to grow. I don't have that 'problem' yet as I haven't made a profit yet and am expecting an overall loss this year. How do I even pay myself a reasonable salary at a loss? Ultimately, I'd rather keep the money in the business so I can keep growing it by going after larger contracts. The goal will be to eventually pay myself so I can pay my bills and get away from my real life job.

And long, long-term would be to hire some people. If it all works out and I win a massive contract, I'd probably turn around and sell.

 

[amp0193]

If it all works out and I win a massive contract, I'd probably turn around and sell.

Big contracts are great, but it would be difficult to sell the business if that contract was more than say... 15% of your revenue. Too risky from a buyer's perspective. Just something to keep in mind.

 

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[CareCPA]

Thank you! I appreciate you taking the time to reply.

From my understanding, everything should still be okay then? I know you can't give me any legal advice so I will make the decision, but would there be any recommendation to trying to stop the S-Corp or just let it go?

It sounds like there is some kind of benefit to it in the long run when profits begin to grow. I don't have that 'problem' yet as I haven't made a profit yet and am expecting an overall loss this year. How do I even pay myself a reasonable salary at a loss? Ultimately, I'd rather keep the money in the business so I can keep growing it by going after larger contracts. The goal will be to eventually pay myself so I can pay my bills and get away from my real life job.

And long, long-term would be to hire some people. If it all works out and I win a massive contract, I'd probably turn around and sell.

Personally, I would probably let it go.
The IRS doesn't expect you to take a wage if you're running a loss, but they do expect you to take a wage before you take distributions. I've even heard stories that they are re-classifying for prior years.

For example, say in your first three years, you have profit of $0, $0, and $100,000. You pay yourself no salary the first two years.
In the third year, you would think it would be reasonable to pay yourself a wage of $60,000, and then distribute the remaining $40,000 to yourself.
The IRS may come back and say that since you didn't pay yourself a wage for the first two years, that $40,000 is really wages.

I have not been able to independently verify this, just heard through the grapevine.

 

[CareCPA]

Minor updates for the new tax law. More forthcoming.

 

[Striver]

An S Corporation must run payroll, and pay its owners a “reasonable salary.” The IRS does not give guidelines as to how much would constitute a reasonable salary.

Do you have any knowledge of audits or problems regarding this aspect? Or maybe even advice on what might be reasonable.

I'll use an old ebay side-business of mine as an example...

Used to make $200 profit a day, with 1 hour of time put into packing and shipping. Yearly profit = $73,000.
My actual work hours were 365.
365 hours x $15/hr(reasonable rate of pay for a packager) = $5475.

Would they have been okay with me paying myself for actual hours worked ($5475), or would they have expected me to pay myself a "reasonable yearly salary"?

 

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[CareCPA]

Do you have any knowledge of audits or problems regarding this aspect? Or maybe even advice on what might be reasonable.

I'll use an old ebay side-business of mine as an example...

Used to make $200 profit a day, with 1 hour of time put into packing and shipping. Yearly profit = $73,000.
My actual work hours were 365.
365 hours x $15/hr(reasonable rate of pay for a packager) = $5475.

Would they have been okay with me paying myself for actual hours worked ($5475), or would they have expected me to pay myself a "reasonable yearly salary"?

As long as you can support that $15 an hour is a reasonable rate of pay, that should be fine.

Keep in mind you probably had other time into the business (sourcing products, creating listings, etc). If you subcontract those things out, then you have a stronger case for supporting your decision to not take all the profit as salary, since you're delegating work. However, you may have to add in time at a "Manager" rate.

 

[Striver]

As long as you can support that $15 an hour is a reasonable rate of pay, that should be fine.

Or even $20/hr (which I doubt anyone makes for just stuffing envelopes). Still a drop in the bucket compared to the total profit.