Has your favorite hobby turned into a cash cow? Are you an independent contractor looking for the most tax advantageous entity for your income and expenses? Maybe you have put in the time with your employer and are ready to venture out on your own? No matter your reason, make sure you have the proper foundation for making your new business venture successful from the start. A popular analogy used in our industry is that of the “three-legged stool.” Without all three legs, your business, or stool, will not be sturdy enough to stand, so what are these legs?
The first leg; make sure you consult your Certified Public Accountant (or CPA) concerning the proper entity to accomplish your goals and limit your tax liability. Depending on expected income, the simple choice of entity could determine whether you are paying anywhere from 0% to over 50% in taxes. There are three main business structures to consider. A Single-Member LLC (Limited Liability Company), not electing corporation treatment, will be subject to both ordinary income and self-employment tax. While income reported on a K-1 to a shareholder of an S Corporation is not subject to self-employment tax, officers are required to take a “reasonable wage” for their services and report as ordinary income subject to FICA withholding. In a C Corporation, the profit is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends, creating a double tax. Depending on your entity, profession and income, there may also be a 20% Qualified Business Income Deduction available as well. These are all things to be considered by your CPA professional.
The second leg; make sure you hire a business attorney to establish and file all of the proper paperwork for your new business entity. Most entities will need to choose a name (and make sure it is not already used), file various paperwork at the state and federal levels to be properly registered, file for an Employer ID Number (EIN), and have proper entity agreements and formation documents. Depending on the entity, it may be necessary to have all contributions, ownership interest, shares owned, officer information, and general partners recorded before the ribbon cutting.
The third leg makes a wobbly stool sturdy. A CERTIFIED FINANCIAL PLANNER® (or CFP®) professional will be well versed in helping a new business owner decide on the proper financial considerations to further set the business up for success. This would include suggesting necessary insurance policies and plans, retirement benefits, the proper financial vehicles to save money for the business and working with the CPA to properly budget for the future.
You can see why it is important to choose the right entity when setting up a business, making sure everything is legally legitimate, and making sure the proper financial plan is in place. There are various ways to make income on your own and even more reasons to decide to do so. No matter your reason, make sure your stool has all three legs to keep you from falling on your face.
Published in the Victoria Advocate
Adam H. Baucom CPA/CFP® is a Senior Tax Manager for Keller & Associates CPAs, PLLC and is an Associate Advisor for KMH Wealth Management, LLC. He has over 10 years of experience in tax planning, tax return preparation and accounting.