How To Select The Best Entity For Your Business. By Juliet Kong, Enrolled Agent Maui County Business Resource Center, August 21st, 2018

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1 How To Select The Best Entity For Your Business By Juliet Kong, Enrolled Agent Maui County Business Resource Center, August 21st, 2018

2 TODAY S WORKSHOP WILL COVER: The 5 Things to Consider When Selecting a Legal Structure The Pros and Cons of 6 Business Entities The Easiest and Least Expensive Way to Get Started Please ask questions during the presentation as needed. Save more individual questions to the end. Slides are available for instant download at

3 What is an Enrolled Agent? Enrolled agents (EAs) are America's Tax Experts. EAs are the only federally licensed tax practitioners who specialize in taxation and also have unlimited rights to represent taxpayers before the IRS. Enrolled means to be licensed to practice by the federal government, and agent means authorized to appear in the place of the taxpayer at the IRS. Only Enrolled Agents, attorneys, and CPAs have unlimited rights to represent taxpayers before the IRS. The Enrolled Agent profession has been regulated by Congress since 1894! What s the difference between a Professional Tax Preparer and an Amateur? The Professional s Commitment to Knowledge!

4 What is a business entity? A business entity is an organization created by one or more natural persons to carry on a trade or business. Business entities are created or formed at the state level, often by filing documents with a state agency such as the Secretary of State. When we talk about entities, we are referring to the type or structure of the business (for example, a corporation) as opposed to what the business does (for example, carpet cleaning services). Business entities are subject to taxation and must file a tax return. Some business entities are considered for federal tax purposes to be not separate from its owner. Such is the case with single-member limited liability companies and sole proprietors. The income and deductions related to such entities are reported on the same tax return as the owner of the business. We call these disregarded entities because the IRS "disregards" the separate name and structure of the business. Small Businesses Definition and Numbers Depending on the industry, a small business could be defined as a maximum of 250 employees or a maximum of 1,500 employees or they could be defined by a maximum of $750,000 to $38.5 million in average annual receipts. (SBA) Small businesses with fewer than 20 employees make up 89.6% of all U.S. business enterprises. On top of that, 23 million businesses in the United States actually have no employees at all meaning there s only an owner going about business by themselves. (SBA) Approximately 540,000 people become new business owners each month. 310 out of every 100,000 adults become new entrepreneurs each month. Predictions are that by 2020 the number of independent workers in America will hit 47.6 million, up from 40.9 million today. (Bureau of Labor Statistics, 2017)

5 THE GIG ECONOMY - Important Tax Considerations A gig economy is an environment in which temporary positions are common and organizations contract with independent workers for short-term engagements. Sharing economy, also known as collaborative consumption, is a trending business concept that highlights the ability (and perhaps the preference) for individuals to rent or borrow goods rather than buy and own them Got a Side Gig? Freelance Taxes 101 Uber Drivers The tax value of a qualified home office lies in the impact on commuting expenses much more than the direct OIH deduction itself Don t miss out on this extra mileage deduction! Drivers may be eligible to pay GET at the reduced wholesale rate on the nontip income it receives from the TNC (Transportation Network Companies) Don t overpay your GET! Airbnb Hosts If the average rental period is 7 days or less and if significant personal services are provided, you have a rental business (Sch C) and not a rental activity (Sch E) You ll be subject to self-employment taxes!

6 General Entity Stereotypes Sole Proprietorship: The one man show. Partnership: The dynamic duo. Limited Liability Corporation: Something you can get behind. Cooperative: By the people for the people. C Corporation: The big money makers. S Corporation: LLC plus.

7 1. Legal liability. To what extent does the owner need to be insulated from legal liability? 2. Tax implications. Based on the individual situation and goals of the business owner, what are the opportunities to minimize taxation? There are many more tax options available to corporations than to proprietorships or partnerships. Double taxation, a common disadvantage often associated with incorporation, can be avoided with S corporation status. Business losses can help reduce personal tax liability, particularly in the early years of a company's existence. 3. Cost of formation and ongoing administration. Tax advantages, however, may not offer enough benefits to offset other costs of conducting business as a corporation including the initial corporation set up costs. Taking care of administrative requirements often eats up the owner's time and therefore creates costs for the business. Record-keeping requirements and the costs associated with them make the sole proprietorship a very popular form of business entity. 4. Flexibility. Your goal is to maximize the flexibility of the ownership structure by considering the unique needs of the business as well as the personal needs of the owner or owners. Individual needs are a critical consideration. No two business situations will be the same, particularly when multiple owners are involved. No two people will have the same goals, concerns or personal financial situations. 5. Future needs. When you're first starting out in business, it's not uncommon to be "caught up in the moment." You're consumed with getting the business off the ground and usually aren't thinking of what the business might look like five or ten-let alone three-years down the road. What will happen to the business after you die? What if, after a few years, you decide to sell your part of a business partnership?

9 Entity #1: Sole Proprietorship A sole proprietorship is the simplest business entity, with one person as the sole owner and operator of the business. If you launch a new business and are the only owner, you are automatically a sole proprietorship under the law. There s no need to register a sole proprietorship with the state, though you might need local business permits or licenses depending on your industry. Freelancers, consultants, and other service professionals commonly work as sole proprietors, but it s also a viable option for more established businesses, such as retail stores, with one person at the helm. Pros of a Sole Proprietorship Easy to start up (no need to register your business with the state). No corporate formalities or paperwork requirements, such as meeting minutes, bylaws, etc. No co-owners or board of directors. You can deduct most business losses on your personal tax return. Tax filing is easy simply fill out and attach Schedule C-Profit or Loss From Business to your personal income tax return. Cons of a Sole Proprietorship As the only owner, you re personally liable for all of the business s debts and liabilities someone who wins a lawsuit against your business can take your personal assets (your car, personal bank accounts, even your home in some situations). There s no real separation between you and the business, so it s more difficult to get a business loan and raise money. It s harder to build business credit without a registered business entity. Sole proprietorships are by far the most popular type of business structure in the US because of how easy they are to set up. There s a lot of overlap between your personal and business finances. The problem is that this same lack of separation can lead to inadequate capitalization, comingling of business and personal funds and challenging bookkeeping due to the blurred line between business and individual activities.

10 Entity #2: General Partnership (GP) Partnerships share a lot of similarities with sole proprietorships the key difference is that the business has two or more owners. There are two kinds of partnerships: general partnerships (GPs) and limited partnerships (LPs). In a general partnership, all partners actively manage the business and share in the profits and losses. Pros of a General Partnership Easy to start up. No corporate formalities or paperwork requirements, such as meeting minutes, bylaws, etc. You don t need to absorb all the business losses on your own because the partners divide the profits and losses. Owners can deduct most business losses on their personal tax returns. Cons of a General Partnership Each owner is personally liable for the business s debts and other liabilities. In some states, each partner may be personally liable for another partner s negligent actions or behavior (this is called joint and several liability). Disputes among partners can unravel the business (a solid partnership agreement can help you avoid this). It s more difficult to get a business loan, land a big client, and build business credit without a registered business entity. A partnership is an entity separate from its partners and is required to file Form 1065 and a state tax return, and to distribute Schedules K-1 to the partners. Partners cannot draw a wage or salary, and they are taxed on their distributive share of income, whether they receive any monetary payouts or not.

11 Entity #3: Limited Partnership (LP) In an Limited Partnership, there are two kinds of partners: those who own, operate, and assume liability for the business (general partners), and those who act only as investors (limited partners, sometimes called silent partners ). Limited partners don t have control over business operations and have fewer liabilities. They typically act as investors in the business and also pay fewer taxes because they have a more tangential role in the company. Pros of a Limited Partnership An LP is a good option for raising money because investors can serve as limited partners without personal liability. General partners get the money they need to operate but maintain authority over business operations. Limited partners can leave anytime without dissolving the business partnership. Cons of a Limited Partnership General partners are personally responsible for the business s debts and liabilities. A limited partner may also face personal liability if they inadvertently take too active a role in the business. Multi-owner businesses that want to raise money from investors often do well as LPs because investors can avoid liability. You might come across yet another business entity structure called a limited liability partnership (LLP). In an LLP, none of the partners have personal liability for the business, but most states only allow law firms, accounting firms, doctor s offices, and other professional service firms to organize as LLPs. These types of businesses can organize as an LLP to avoid each partner from having liability for the other s actions. For example, if one doctor in a medical practice commits malpractice, having an LLP lets the other doctors avoid liability.

12 Entity #4: C-Corporation A C-corporation is an independent legal entity that exists separately from the company s owners. Shareholders (the owners), a board of directors, and officers have control over the corporation, though one person in a C-corp can fulfill all of these roles, so it s possible to create a corporation with you in charge of everything. Pros of a C-corporation Owners (shareholders) don t have personal liability for the business s debts and liabilities. C-corporations are eligible for more tax deductions than any other type of business. C-corporation owners pay lower self-employment taxes. You have the ability to offer and transfer stock options, which can help you raise money in the future. Sale of original stock held for at least 5 years can be potentially tax-free. Cons of a C-corporation More expensive to create and maintain than sole proprietorships and partnerships. Methods for incorporating, fees, and required forms vary by state. C-corporations face double taxation: The company pays taxes on the corporate tax return (Form 1120), and then shareholders pay taxes on dividends on their personal tax returns (to minimize double taxation, use: W-2, loans, fringe benefits). Owners cannot deduct business losses on their personal tax return. There are a lot of formalities that corporations have to meet, such as holding board meetings and shareholder meetings, keeping meeting minutes, and creating bylaws. Most small businesses pass over C-corps when deciding how to structure their business, but they can be a good choice as your business grows and you find yourself needing more legal protections. The biggest benefit of a C-corp is limited liability. If someone sues the business, they are limited to taking business assets to cover the judgment they can t come after your home, car, or other personal assets. Corporations are a mixed bag from a tax perspective there are more tax deductions and fewer self-employment taxes, but there s the possibility of double taxation if you plan to offer dividends. Owners who invest profits back into the business as opposed to taking dividends are more likely to benefit under a corporate structure.

13 Entity #5: S-Corporation An S-corporation preserves the limited liability that comes with a C-corporation but is a pass-through entity for tax purposes. This means that, similar to a sole prop or partnership, an S-corp s profits and losses pass through to the owners personal tax returns. There s no corporate-level taxation for an S-corp. Pros of an S-corporation Owners (shareholders) don t have personal liability for the business s debts and liabilities. No corporate taxation and no double taxation: An S-corp is a pass-through entity, so the government taxes it much like a sole proprietorship or partnership. Losses that are passed through to the shareholders can potentially be deducted again other income on the individual returns. Cons of an S-corporation Shareholders can be taxed on moneys that they have not received. An S-corp is an entity separate from its shareholders and is required to file Form 1120-S and a state tax return, and to distribute Schedules K-1 to the shareholders. Like C-corporations, S-corporations are more expensive to create and to keep. There are more limits on issuing stock (100 shareholders max, one type of stock, no foreign holders). Reasonable Compensation: the S-corp will need to establish payroll at least for the active shareholder/owner (additional bookkeeping and payroll costs). The more-than-2% shareholder of the entity has limited enjoyment of tax-free fringe benefits that may be available to other employees of the business. You still need to comply with corporate formalities, like creating bylaws and holding board and shareholder meetings.

14 Entity #6: Limited Liability Company (LLC) A limited liability company takes positive features from each of the other business entity types. Like corporations, LLCs offer limited liability protections but they have few paperwork and ongoing requirements, and in that sense, they are more like sole proprietorships and partnerships. It is an entity that is not recognized by the IRS. The entity may have a single member (SMLLC) or multiple members (MMLLC). Another big benefit is that you can choose how you want the IRS to tax your LLC. You can elect to have the IRS treat you as a corporation or as a pass-through entity on your taxes. Pros of an LLC Owners don t have personal liability for the business s debts or liabilities. Ease of formation: not as many corporate formalities compared to an S-corp or C-corp. Flexibility in tax treatment: you can choose whether you want your LLC to be taxed as a sole proprietorship, a partnership or as a C or S corporation. Cons of an LLC It s more expensive to create an LLC than a sole proprietorship or partnership (requires registration with the state). Confusion and misunderstanding of tax complexities: the LLC owner may not understand the implication of filing as a corporation and its requirements for recordkeeping, tax regulations, and similar provisions. For example, co-mingling of personal and business funds may raise taxation issues. Five-year lock-in : once the LLC has filed Forms 8832 or 2553 and chosen a tax treatment, it is barred from changing that election for 60 months.

15 BUSINESS ENTITY SUMMARY Comprehensive Chart of Entity Comparison Provided by The National Association of Tax Professionals

16 3 Common Scenarios Here are three common scenarios and the entity-choice implications: 1. Business generates tax losses. For a business that consistently generates losses, there s no tax advantage to operating as a C corporation. Losses from C corporations can t be deducted by their owners. A pass-through entity will generally make more sense because losses pass through to the owners personal tax returns. 2. Business distributes all profits to owners. For a profitable business that pays out all income to the owners, operating as a pass-through entity generally will be better if significant QBI deductions are available. If not, it s probably a toss-up in terms of tax liability. 3. Business retains all profits to finance growth. For a business that s profitable but holds on to its profits to fund future growth strategies, operating as a C corporation generally will be advantageous if the corporation is a qualified small business (QSB). Why? A 100% gain exclusion may be available for QSB stock sale gains. If QSB status is unavailable, operating as a C corporation is still probably preferred unless significant QBI deductions would be available at the owner level.

17 New Tax Plan s Impact on Business Entity Choices The Tax Cuts and Jobs Act took effect this year and impacts some of the tax considerations around your business entity choice. Congress made two main changes that impact small businesses: 1. C-corporations are subject to a flat 21% corporate tax rate, a significant cut from the previous 35% corporate tax rate. 2. The new Qualified Business Income Deduction: owners of pass-through entities can deduct 20% of business income on their personal income tax returns. These include owners of sole proprietorships, S-corps, LLCs that have elected passthrough tax status, and general partners in a partnership. There are some limitations on the deduction based on business type and income level. Deductions for unreimbursed employee expenses have been eliminated: expenses that employees incur in their job like tools and supplies, required uniforms not suitable for ordinary wear, dues and subscriptions, unreimbursed travel and mileage, as well as the home office deduction are no longer deductible on personal returns. Shifting some work to be performed as an independent contractor might offset these missed deductions and make use of the QBI benefit.

18 Keep the following in mind when deciding among the different types of business entities: Sole props and general partnerships are good starter entities. As your business grows and generates more income, consider registering as an LLC or corp. Think through the pros and cons of each business entity in terms of legal protection, tax treatment, and government requirements. Consult a business lawyer and accountant to get specific help for your business. Start Out Simple (SOS) and increase complexity when the need arises. There s no one best business entity choice for all small businesses, but there is a best option for your small business right now. Use the tips above to figure out what that is.

20 The Easiest and Least Expensive Way to Get Started The ABCs of Setting Up an LLC Go see Angela or go to the Department of Commerce and Consumer Affairs website Set up your Articles Of Organization Establish Your Operating Agreement File your BB-1 to get your GET # Open Your Bank Accounts (Operations + Savings for Taxes, Purchases, etc) Be Audit-Proof / Keep Your Bookkeeping In Order/ No Commingling of personal and business expenses! Give Angela Cash or Check (no Credit Cards )- DCCA List of Fees Convert to a Corporation as needed (LLC defaults to sole proprietorship or partnership) Before the ABCs, do the Ds and Es Search for your dba(s) in Hawaii/Nationwide/Worldwide Get Your Employer s Identification Number (EIN)

21 Choose Your Business Names and DBAs Well A name is the first point of contact A name conveys elements of your image A name conveys what you do A name can affect how you run your business A name can affect your style Maui Paradise Entertainment LLC Maui Paradise Play House dba Maui Paradise Pictures dba Maui Paradise Gifts dba

22 Be Audit-Proof! SUBSTANTIATION= RECORDS + RECEIPTS = DEDUCTIONS DOCUMENT, DOCUMENT, DOCUMENT! #1: Keep annual meeting minutes for your business to support activity reported on your business tax return(s). #2: Have accurate bookkeeping that is up-to-date. #3: Scan and store receipts for expenses, particularly travel and meals. #4: Have signed loan documents between you and your entities for any loans between you and your entities. #5: Save agreements to buy or sell assets, such as real estate, equipment and vehicles. #6: Have signed agreements between you and your entities (or businesses) for services performed by or for your entity. #7: Have signed agreements between your entities (or businesses) for services performed by one of your businesses for another one of your businesses. #8: List the business activities performed in your home office. #9: Calculate the percentage of your home used for your office. #10: Track your business miles in a mileage log or app to support the business use of your vehicle.

23 Saving Money And Reducing Taxes Year-Round, Year after Year That s S.M.A.R.T! Thank You For Your Participation! Questions?

Build a Successful Notary Business by Understanding Your Taxes. Presented by David M. Green E.A. CNSA

Build a Successful Notary Business by Understanding Your Taxes Presented by David M. Green E.A. CNSA 1 Build a Successful Notary Business by Understanding Your Taxes David M. Green E.A., I own David M