in the last post, we took a quick (very quick) look at the various corporate structures that are available under the us tax code. if you missed it, here's a shortcut.
so, to guide you through our own process, let me give you some of the particulars - there were going to be 2 co-equal owners; a simple operating agreement we'd hammered out; and a desire to keep the paperwork to a minimum so that we could focus on the work. that's what I went to the adviser with.
it's the questions that came back to us, though, that really made our decision. in terms of the major factors, what we were asked to consider were:
liability - this was the easiest. we wanted protection between the company and our personal assets. so, that took a Partnership structure off the table. what was left: LLC, S-Corp, C-Corp.
paperwork and basic tax implications - again, this was an easier decision. C-Corp's had too rigid a company structure for us. throw in the double taxation dilemma and the fact that we didn't see growing the company to be 100+ people or have more than 500 shareholders and it was easy to let that one go. we're down to an LLC or S-Corp...
family income situations - this was actually fairly significant, since both the LLC and S-Corp are 'pass through' corporations, meaning that that ALL of the income the company generates is treated as personal income (now, before you panic, all the expenses of the company are deducted, so it's not like a company making 1M+ gross income will mean the owner pays tax on that full amount. but you do pay on all the net income). for us, this meant looking at each of our own situations and deciding, in combination with our spouses income, what kind of tax bracket each of us may be in or close to. and, for me and my partner, those situations were quite different. in the end, there was no distinct advantage between one structure or the other relative to our individual situations.
one side note: the main difference between the LLC and S is how each treats distributions/dividends, which get treated a little differently from a tax perspective than regular income. in short, the income from dividends is not subject to the payroll tax. now, what you can't do is say everything you take is a dividend and you receive no salary - the IRS will come calling if you do. but, according to our CPA, you can do a 75/25 split pretty comfortably. so, in our case, we lowered our base salary and make up the difference as a dividend.
one other side note: the choice of structure can be influenced by the accounting method you choose. like most small companies, we're on a 'cash basis', which means what we actually collect is what we actually make. the upside is it's easy to do the books with this method. however, you can't claim any losses or 'gifts in kind' as a donation since there's no actual money coming in. meaning, if your client stiffs you on your invoice, you can't write that off as a loss. or, if you donate services to a non-profit, you can't write off the cash value of that time. making the jump to accrual from a cash method is allowed by the irs, but once you go to accrual, you can never go back. so, keep that in mind as well. most firms, honestly, are probably on accrual for the simple reasons outlined above.
one last side note: we found out a painful lesson about how the pass through income works when, at the end of our first really good year, we figured out that the huge amount we'd left in the bank on Dec. 31 (our end of fiscal year) was going to be charged to our personal tax load, even though we didn't "spend" it on salaries or dividends. that hurt. what we learned was, for an LLC on a cash basis, that you want the books at the end of the year to either be as close to zero as possible or be prepared to set aside a chunk of money to pay the estimated tax on it. just saying...
so, in the end, we decided that the LLC would be the best vehicle since it would address all of our concerns adequately enough. we elected to be taxed as an S-Corp with the IRS and file accordingly. we do have a CPA that does all our taxes and a part time office manager that does our book-keeping and payroll. best. decision. ever. (we tried, the first year, to do it ourselves. never, ever, again).
really, though, what you all really want to know is: how in the world does this apply to me?
the short answer is: i don't know. and, i can't stress this enough, there's almost no one on this site that's probably going to be able to give you that answer. it's one of the few legit reasons talking to a tax attorney or CPA will be the best money you spend starting up a firm. (and that's not just to address the legal disclaimers of anything i've said - it's the honest truth. i had a lot of conversations with a CPA, who happens to be my cousin and it was still a tough call in the end). so, if you're serious about starting up a firm, spend the time and resources to have someone look at your particular situation. it'll definitely pay dividends down the line.
some resources you may want to look at for further reading:
staring a business - the official irs website on everything you need to start.
applying for an EIN - get your official employer identification number here.
Central to the blog is a long running interest in how we construct practices that enable and promote the kind of work we are all most interested in. From how firms are run, structured, and constructed, the main focus will be on exploring, expanding and demystifying how firms operate. I’ll be interviewing different practices – from startups to nationally recognized firms, bringing to print at least one a month. Our focus will be connecting Archinect readers with the business of practice.