This is part five of the Business Essentials Series.
Business Essential #5 – How Do We Protect Wealth
What do Business Owners Want? More transactions, more relationships, more free time, less costs, less taxes, better employees, better products, higher sales and higher margins.
Lions and Tigers and Bears. Oh My. Sole Proprietorships, General Partnerships, Corporations, Limited Liability Companies. Oh My. This is an area that where the decision as to when and why to use which kind of entity can be very confusing.
Most people when they attempt to do these themselves fail and sometime they fail miserably. Sometimes they don’t even get them set up and most of the time they never complete all that is supposed to be completed. Imagine you going into a job with what you do best and you don’t get it done right or completely. You wouldn’t stand for that, yet people who think they can do these entities themselves are doing just that. And the risk can be disastrous. Everything you thought you were protecting could be destroyed.
My goal in this week’s article is not to get into every grain of detail of the differences between the entities but I do want to paint a broad brush.
Simply, a sole proprietorship will not protect you from creditors and you must pay self employment tax on your net income. Do not pass go, do not collect 200. This means that nothing you do can offset the self employment tax except pay it. The self employment tax, also known as the payroll taxes, are a tax on top of any income tax. The self employment tax is what you pay for the privilege of being self-employed, working for yourself, so you get to pay the social security and medicare portion of payroll taxes for yourself and you as your own employer get to pay the same amount. What a deal Huh?
Generally speaking, a general partnership is a horrible way to do business. A general partnership amounts to two people doing business together for any reason. Even owning rental property together technically qualifies you for general partnership status. In a general partnership, there is no protection from creditors and if your partner does something really stupid and causes the company liability you could be 100% responsible. Any tax consequences from the money you make can subject you to the self employment tax as well.
Corporations are a good way to do business to give you protection from liability and in some cases, tax benefits. Corporations are broken down tax wise into two types. A C corporation and and S corporation. The two are taxed very differently. Usually, in my opinion, the decision to use a corporation comes down to liability. If you have a business where you have risk of being sued, such as selling food products, you should have a corporation no matter how much money you may make. If you have a business that doesn’t have a lot of liability risk, then having a corporation and using the S corporation tax rules can help save you from the self employment tax. Since everyone’s situation is different, please do not rely on this small commentary as legal or tax advice for your situation. Cuz it isn’t.
Limited Liability Companies
I love LLC’s, when they deal with real estate. Because that is what they were intended for. Many attorneys will set up LLC’s for business because many don’t have any clue about the tax implications. When business is done in an LLC, while there is liability protection the bad news is that you are still subject to self employment taxes. There is that darn tax problem again.
Lions and Tigers and Bears. Which one is right for you takes having the right conversation with the right professional. And when you get a tax attorney you get both benefits of someone versed in knowing the differences in entities and the tax implications.
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California Estate Planning Attorney