Unlocking the Power of LLC
Hey Entrepreneur,
Are you wondering if you should form an LLC or S Corporation for your service-based business? The answer is it depends.
This is the question my tax clients ask me the most and I would like to share some information to help you make an informed decision. Do know that what I am sharing does not consider all nuances related to your situation, so be sure to speak to your tax accountant before pulling the trigger on forming an entity.
There are three reasons to form an LLC:
Energetic - it symbolizes that you are serious in this new or existing business endeavor. This can add an invisible layer of confidence in how you and others perceive this business.
Liability Protection - the entity creates a layer of protection between you and your personal assets should something go wrong. Often, you can get insurance that would cost you less than having this business structure. If you own property this aspect becomes more relevant. If this feels like an area of concern, you will want to discuss it further with a lawyer and your accountant.
Tax savings – this is my favorite reason to have an entity. However, an LLC in and of itself does not save you taxes. Forming an LLC and then making an S election does. For an S Corporation to save you more taxes than it costs to have this entity, your profit would need to be $40,000 in most states and $50,000 or more in California. To calculate profit, take your business income minus expenses.
The are a few nuances that will impact tax savings of having an S Corporation and should contribute to the consideration of whether an LLC or S Corporation is right for you.
If you live in California there is an annual $800 tax which is why your profit would need to be higher in order for the tax savings to outweigh the costs. Most states have an annual tax of $0 to $200 and Massachusetts is a bit higher.
Our current US tax law has a Qualified Business Income Deduction in place where potentially 20% of your profit would be exempt from federal taxes. This exemption is allowed for entrepreneurs who have an S Corporation, LLCs, and self-employed individuals alike. Should this deduction go away, then it would be advantageous to form an entity when your profit is even lower.
When you have an S Corporation you will need to pay yourself “reasonable compensation” and hire a payroll company to process your payroll, file your quarterly payroll tax returns, file your annual tax returns and pay in your taxes for you. This will cost you about $550 to $700 a year depending on the level of service you get.
Another cost associated with having an S Corporation is you will have to file an entity tax return in addition to your personal tax return. Along with your entity tax return there should be a year-end tax projection to ensure you are in compliance and taking advantage of all tax deductions available to you. This will run about $1,200 to $3,000 a year depending on the level of service required and the type of tax firm you hire.
If you form an LLC and do not make an S election you would be considered a single member LLC and the business income and expenses would be included on your personal tax return.
The cost to form an LLC or S Corporation is about $600 via Legal Zoom, approximately $1,000 from a legal assistant and $1,500 to $3,000 from a law firm. I do not recommend forming an entity yourself as errors you might make could end up costing you more money and hassles in the long run.
An alternative to forming an entity is you can obtain a business name and federal tax ID number which is called a DBA, doing business as. Or you can continue to operate as an individual.
If you are feeling a little overwhelmed by all this information do not worry. You can email me your questions and I will make an IG video answering your question(s) so you and other entrepreneurs can benefit.
Warmly,
Rana, Conscious CPA