Clients who decide to make a "fresh start" after April 15 and launch their own business venture may seek guidance from their tax professional regarding the form or business structure they should choose. The tax pro's response should be simple enough to be understandable without confusing the issues, and comprehensive enough to include potential snags or traps for the unwary.
Think of business structures as different vehicles that can get you to the same destination — business success — but with very different rides along the way, said Miklos Ringbauer, a CPA in Southern California.
An LLC, or limited liability company, offers a favorable blend of flexibility and protection. It separates personal assets from business liabilities, while giving options on how the business owner is taxed. It's the go-to choice for solopreneurs and business owners who want simplicity without sacrificing protection.
S corporations function technically as corporations but with tax advantages flowing through to the personal returns of the owners. The owner can potentially slash their self-employment tax by paying themselves a reasonable salary plus distributions. There are restrictions, however: They are limited to 100 shareholders, all of whom must be U.S. citizens or residents, and there can be only one class of stock.
C corporations are the corporate giants, existing as completely separate entities with their own tax rates. They can have unlimited shareholders of any nationality and multiple classes of stock. The drawback, of course, is double taxation, due to a tax on profits at the corporate level and again when distributed as dividends.
Although there are numerous "do-it-yourself" websites and incorporation kits, Ringbauer does not recommend them for someone starting a new business.
"There's an incredible amount of information on the internet, but much of it is not suitable or is incomplete for a taxpayer when they decide to make a choice," he said. "It is extremely valuable to speak with a professional — a trusted CPA tax advisor and a lawyer. I can't tell you how often I've seen DIY-created entities from a novice who used an online platform. The system asked the user to check certain boxes, and the user doesn't know whether that's the right checkbox or a wrong addition to their bylaws or to their incorporation documents. … It's very valuable to engage an attorney to do this upfront, because once you do the incorporation and order your bylaws, you might have to spend an incredible amount of financial resources upfront to fix it if it's incorrect."
"Most people are aware of LLCs, S corporations and C corporations," he said. "One unique thing to know is that, except in a few restricted cases, it does not matter what entities you incorporate; you can elect to be taxed as a different type of structure. For example, you can create an LLC for state purposes, but as a taxpayer, you can choose to be taxed as a C corporation or as an S corporation on the federal level. With the projected tax law changes, it's going to be very important."
It's important to discuss the projected lifecycle of the entity with the client and what the taxpayer intends to do. Do they envision selling it, passing it to their heirs, dissolving it or going public? The answer may determine potential tax strategies and timing.
While California prohibits accountants from incorporating an entity, in other states a CPA can do so, according to Ringbauer. And in states like California, it's important for an accountant to provide guidance as to which rules and filing requirements and everything else the new business venture will be subject to.
The requirement that an S corporation not have a foreign member can result in a disqualification in the event of a divorce where both spouses own shares, and one is a noncitizen, he noted.
"If part of the shares will be given to the noncitizen spouse, in the old days that would automatically disqualify the entity from its S corporation status," he explained. "But from 2017 on, the IRS made the rule change that the entity has the ability to correct that by having the noncitizen spouse sell their shares within a very short period of time in order for the entity not to lose its S status."
