As I mentioned last month, I made my hosting business an LLC. There were some questions here on the forum about tax savings, advantages, etc.
Last night, my lawyer did a free incorporation seminar. There were about 10 of us at the meeting and of those, I think 6 had already incorporated at the first of the year and the others were interested.
So, here's what I learned ...
When you incorporate, the business becomes a separate entity from you. The business is no longer you, but you work for the business.
C-Corp: The C-Corp is for large corporations. It is bad for the small business because it is basically a double taxation. The corporation is taxed as an entity, then you get taxed on your wages/dividends that you take from the business. Bad news for small business.
S-Corp and LLC: The business is not taxed on its own, all the money runs to the stock holders/members. Good for small business.
S-Corps have "stockholders" and LLCs have "members".
Small disadvantages to both are slightly more record keeping and your CPA will charge you more to do your taxes, especially more if you are an S-Corp.
I did my LLC for the limited liability protection. If someone wants to sue me for something related to my business, they can only sue the business, not me personally. Only the assets owned by the business are at risk (More on that later). They now can't try to take my house, car, cash and investments in a business claim. One note to that, my lawyer said to make sure that you keep everything up to date and follow the rules. The corporation is to hold meetings keep minutes, etc. Even if you are the only member do those things and keep the proper records. If you don't have those things in place and you are taken to court, their first attack will likely be against weather or not you are really acting like a corporation or if you are just trying to hide under the title. If you don't have everything in place, the court will likely rule that you are personally responsible because your corporation does not look legit.
My lawyer said that of the businesses he's helped incorporate, three have ended up in court. Of those three, one didn't keep the records and ended up losing personal assets because their corporation didn't look like a real corporation in its operation.
I also learned that there are indeed ways to save on taxes with both S-Corps and LLC's but the S-Corp can save you more. There are ways to save that I didn't know about before last night.
It basically comes down to the type of income you receive from the business. Wages are subject to all taxes. Social Security and Medicare taxes are 15.3% of wages.
In the S-Corp, you save on taxes by paying dividends. Dividends and other incomes from the business are NOT subject to the 15.3% tax . . . only wages are.
So, you just pay yourself in dividends, right? No. Its not that simple. You still have to pay yourself a wage first and the wage should be based on what other people make doing that same job in your area. Then money above and beyond that can be taken as dividends . . . up to 50% of your total income can be dividends. If you try to take more dividends than wage, the IRS is going to come lookin' for ya and tell you you can't do that.
Let's use an example: Lets pretend there is a guy named "Jim" and he's going to start . . . oh . . . I dunno . . . a cleaning business. Lets say Jim sets up his business as an S-Corp.
Jim needs to set his wage. Lets say in his area, someone working for a good cleaning firm can make $36,000 a year. So, Jim sets his personal wage at $36,000. Assuming the business makes enough to pay him that wage, he will have to pay all taxes, including the 15.3% on $36,000. He didn't save any money yet. Simple enough.
Now, lets say, it turned out to be a really good year and the business still had $20,000 left at the end of the year. Jim can withdraw that as a dividend. He still has to pay fed and state income tax on that dividend income, but since its not wages, its not subject to the 15.3% SSI tax. This lets him keep $3,060 for himself that if it was a wage would have gone to tax.
This is the main advantage of an S-Corp over an LLC. Only the S-Corp pays dividends from the stock. LLCs don't have stock but you can come up with other ways to save in both corporations.
Lets say that Jim owns a nice little building where he keeps his truck, cleaning equipment, etc.
Jim can rent or lease that building to the corporation. Lets say that similar buildings in the area are renting for $1,000/month. The business can then pay Jim $1,000/month rent on that building. To the business, it is an expense that offsets income. To Jim, it is rent income. Like the dividends, that $1,000 rent income is not subject to the 15.3% tax which saves him $153 in taxes every month. Other things can be handled the same way.
Again, you have to be realistic in that or the IRS could get cranky about it. If you take home $10,000 in wage and $50,000 in "rent", that might get you in trouble . . . unless you can justify the "rent" and show it is legit.
Now, the "more on that later". Another advantage of Jim renting the building to the corporation is in the limited liability. Lets say Jim is cleaning and breaks something really expensive and is taken to court. Sure, he should have liability insurance too, but if the business is renting the building, no one can go after it in a court settlement because the business doesn't own the building, its only renting from Jim. It would be just like the building was being rented from another individual.
Anyway, thats the basics of what I learned. It makes me start thinking of ways I could save a little on taxes. In my case, it won't be much right now as there are not too many things I can rent or lease to the business. The S-Corp is a little more work, but it can save you more in the dividends thing. My lawyer said that if you start as an LLC and then the business gets to where you are making more than what you would expect to take as a wage, then its time to "upgrade" from an LLC to S-Corp. Until, that time, stay an LLC because its a little easier on you and your accountant/CPA.
