Today’s Basic Training query comes from a solopreneur who is stymied by needing to take the next step in forming a business entity. It certainly can get confusing. There are legal considerations, tax considerations, and cost considerations, just to name a few. Plus, there’s the pressure to make the perfect choice before your business has really had a chance to unfold. No wonder entrepreneurs get that “deer-in-the-headlights” look when they think of it!
Q.: I am in Alabama, and I am an independent insurance agent. My CPA is saying that I need to incorporate my business for tax reasons. I am the owner and the only employee. I am 1099’nd under my personal social security number. I have a dba for my business name. I’m searching to see if I need to do an LLC, or an C, or S Corp. I am confused because it is only me and an LLC looks to be for maybe a partnership. I want to save on my taxes, but I am confused on which way to go. I have talked to other tax preparers and they are no help either. As of now I use my personal checking account for everything. I was told that I need to get an EIN, and keep everything separate and I would pay myself a salary.
A.: When choosing a form of business entity, there is always a delicate balance between the legal and tax issues involved.
Here are some general guidelines:
- It’s often smart to form a business entity–not just for tax reasons, but also to get the benefits of shielding your personal liability. Both corporations and LLCs are designed to shield you from personal liability UNLESS (like with lawyers), state law doesn’t permit you to shield yourself from malpractice/professional liability.
- If you are the only owner of your business, and you don’t foresee bringing in any other business owners, many states permit LLCs and corporations to be owned by one person. If that is the case in Alabama (and if the costs for forming LLCs and corporations are similar), at that point your decision of which form to choose may well rest on which form will provide you with better tax advantages.
- Because forming a business entity involves both legal and tax considerations, speaking to tax preparers will only give you part of the guidance you need. That’s why it’s important to also consult with a local business attorney, so that you can get the full scoop on your legal options. You may want to reach out to your local bar association for referrals, or speak to your colleagues to find out who they have used for their business formation issues.
- Once you speak to a local business attorney to get clear on your options and preferences for business form, then confirm your assessment with your accountant to make sure that the best choice from a legal perspective is also the best choice from a tax perspective. LLCs and corporations (both S and C) are taxed somewhat differently. Based on what you’ve been earning over the last couple of years, your CPA should be able to estimate what you would pay in taxes if you were an LLC versus an S Corp versus a C Corp. if your CPA cannot do this for you, you may want to switch to an accountant who is more familiar with the different tax regimens.
- For reasons of “good business hygiene,” you should definitely consider obtaining a separate business bank account— whether or not you form a separate entity. Usually, all it takes is to go into your bank with a copy of your business registration.
- Once you’ve formed a new entity, you can easily obtain an EIN online through www.irs.gov.