Which Business Entity Structure is right for me and why?

When you decide to start a business often the first question you face after deciding what business you will be doing is “Which entity should I choose?”. This slows down many entrepreneurs in the start-up process. This is not taught in elementary school, college, business school or even most law schools. Entrepreneurs are often stuck searching the web, reading books.

However, at IncorpTaxAct, this is our lifeblood. We live and breathe this – and enjoy it. We are patient to make sure you can make an informed decision to help your business succeed.

Very commonly asked questions are, “Which entity should I choose,” “What is Inc.,” “What does Co. mean,” “What is LLC,” “What does LLC stand for,” or “Ltd vs. LLC?” Before you incorporate, you need to choose which type of entity is right for you.

Businesses are formed at the state level, and state law differs with regard to these entities. Let’s understand or find out simple answers to the above questions –

“Which entity should I choose,”

There are number are options available and depending on your business requirement and future plans you can decide what entity you want to choose. The available options are –

Sole Proprietorship (or DBA– doing business as) – no liability protection whatsoever, inexpensive to form, but very risky.

GP (General Partnership) – no personal liability protection – partners are each jointly and separately responsible for all of their partners actions,

LP (Limited Partnership) – requires both active managers called general partners and passive investors called limited partners – Weakness: does not protect the general partner from personal liability,

LLP (Limited Liability Partnership) – usually only for professionals like lawyers and doctors – Weakness: does not protect you from your own negligence,

LLLP (Limited Liability Limited Partnership) – same as LP, but it offers general partner personal liability protection – Weakness: unusual form of entity that is similar to an LLC, but unnecessarily complex,

If you choose to incorporate a business, you move from a Sole Proprietorship or General Partnership into a company that’s recognized by a state of incorporation. This makes it a legal business entity that is separate from those who founded it. This new structure falls into one of two categories:

LLC (Limited Liability Company)

OR

INC (Corporation or Incorporation)

Which is better option an Incorporation or an LLC?

There are three types of Business entities most of the Start up companies chose from, that is LLC a limited Liability company and Incorporation is further divided in to a C Corp and an S corp. The critical factor when deciding between an LLC, C Corp and an S Corp is whether you will be seeking an outside investor and whether the entity will start making profit soon.

What Does LLC Mean?

LLC stands for Limited Liability Company. Generally speaking, the best form of entity for most small businesses and property owners is the Limited Liability Company (LLC).

Formation – An LLC is formed by one or more owners, called Members by filing an Articles of Organization.

Ownership – The owners of an LLC are called “members,” and each member owns a designated percentage of the company, sometimes called a “membership interest.” Membership in an LLC may be more difficult to transfer than shares in a corporation. An LLC’s operating agreement will typically specify whether and how membership interests can be transferred. In some states, if a member leaves an LLC and the operating agreement does not specify otherwise, the LLC must be dissolved.

Taxation – LLCs have flexible tax structure. An LLC is taxed as a pass-through entity by default. This means that the profits of the business are “passed through” to the owners (called members). By default, a single-member LLC is taxed like a sole proprietorship and a multi-member LLC is taxed like a partnership. That means that the LLC’s members report and pay tax on business income as part of their personal tax returns. LLC members—unlike corporate shareholders—may also be liable for self-employment taxes.

Management – LLCs are a newer concept, and they are designed to be more flexible in the way they are managed. An LLC can be managed by its members or by a group of managers. Typically, in a member-managed LLC, the owners are heavily involved in running the business, while a manager-managed LLC usually has investors who don’t have an active role.

Liability Protection – Limited liability is a type of protection for your personal assets. It ensures that your personal liability for the business’ debts and obligations is no more than the amount of money you invested in the business. This protects your home, automobiles, and other personal assets from being used to pay off any debts accrued by your business. Without limited liability protection, your home could be used as collateral to repay the businesses debt after a lawsuit or bankruptcy. This is, by far, one of the greatest advantages gained by forming a business entity.

What Does INC. or Corp. Mean?

The abbreviations “INC.” and “Corp.” indicate that a business is a corporation. Both LLCs and corporations are formed by filing forms with the state. Both protect their owners from liability for business obligations. There are two types of corporations, an S corporation and a C corporation. There are many benefits to incorporation, such as being protected from personal liability and having credibility with your customers. There are also specific pros and cons to each incorporation type.

Formation – An INC. or a Corp. is formed by filing an Articles of Incorporation. Articles of incorporation is a set of formal documents filed with a government body to legally document the creation of a corporation. Articles of incorporation must contain pertinent information such as the firm’s name, street address, agent for service of process and the amount and type of stock to be issued.

Ownership – A corporation can issue shares of stock and sell percentages of the business to its owners, which are called shareholders. These shareholders can transfer shares, purchasing more stock to own a larger percentage of the company, or selling off stock to own less. If your business is one that wants to attract outside investors, a corporation may be the best entity for it. A corporation also exists in perpetuity separate from the owners, meaning that a corporation remains in existence even when an owner leaves or divests from the company.

Taxation – Corporations are taxed as a separate legal entity, which can earn its own income. Corporations are responsible for paying tax on their profits, (corporate tax), and tax on dividends the entity distributes to its shareholders. A “C” corporation pays taxes on profits. Shareholders pay personal tax on the dividends they receive. Since dividends are not tax deductible (like salaries and bonuses), dividends are taxed twice. This is referred to as “Double Taxation”.

An S corporation doesn’t pay corporate income tax, but the corporation’s profits pass through to the shareholders’ personal tax returns, and each shareholder pays tax on his or her share of the profits. Corporations that have 100 or fewer shareholders and meet other requirements can avoid double taxation by choosing to be taxed as S corporations.

Management – Corporations have been around for a long time, and they have a fairly standard and rigid management structure. A corporation must have a formal structure with a Board of Directors handling the management responsibilities of generating profits for the shareholders. Corporate officers are assigned to handle the day-to-day operations of the business. In larger corporations, shareholders are less likely to be involved in running the business. The rights and responsibilities of the directors, officers and shareholders are spelled out in the corporation’s bylaws. The shareholders are considered owners of the corporation but remain separate from business decisions and daily operations of the corporation. However, shareholders retain the power to elect directors, and individual shareholders can be elected as a director or appointed as an officer.

Liability Protection – A corporation is an independent legal entity created under state law with a legal existence that’s separate and distinct from its owners. Corporations are the most widely accepted and well-established entities for investors to protect themselves from personal liability for the actions and debts of a business. A stockholder of a corporation will only be held personally liable for the actions and debts of the business up to the amount of such stockholders’ investment, regardless of the stockholders’ involvement in the management of the business.

Please note that the contents of this document may not cover all the required points for your business. This document is subject to change without notice. For questions please contact Pramod Sathe at pramod@incorptaxact.com or call us at +1 (770) 682-3119. You can also visit http://www.incorptaxact.com for more information.

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Foreign Bank Account Reporting (FBAR)

FBAR was created as part of a US initiative to uncover hidden monies in offshore accounts. FBAR has been around for years. The IRS is forcing those with money in overseas bank accounts to disclose those accounts if balances exceed the threshold. Keep in mind that those filing FBAR aren’t taxed on the balance of the accounts or anything of the sort—it’s truly just a reporting requirement so the IRS knows what money lies overseas.

Any US person with a foreign account balance of $10,000 or more at any point during the tax year will need to file. The threshold is also an aggregate amount—meaning, if you have multiple accounts, it’s the total balance of all of your accounts that trigger a filing requirement. So, if you are thinking that keeping $3,500 in one account and $7,500 in another will enable you to avoid filing, you are incorrect. This also applies to those who simply have signing authority over an overseas account. That’s an important thing to remember, as the account doesn’t have to be YOUR account. To explain further, signature or authority means the authority of an individual to control the disposition of money, funds or other assets held in a financial account by direct communication to the person with whom the financial account is maintained.

Along with your bank account balances you also need to report Foreign stock or securities held in a financial account at a foreign financial institution – The account itself must be reported but the contents of the account do not need to be reported separately, Financial account held at a foreign branch of a US bank, Foreign mutual funds and Foreign-issued life insurance or annuity contract with a cash-value.

FBAR is filed separately to the Department of the Treasury. You have to submit it electronically through the BSA e-filing site. This form is also necessary if you hold joint accounts. Your spouse would sign this form to allow you to file on their behalf. Keep in mind that if your spouse has other accounts you are not on that he/she needs to file (i.e. individual accounts), they must file their FBAR separately (including the FBAR for your joint account). The filing deadline is June 30th each year and unlike your Federal Tax Return, no extensions are available.

For those whose lack of filing was non-willful (meaning you truly didn’t know about your reporting obligation), the fine can be $10,000 per violation. If it is determined that you purposely avoided filing, the fine can be $100,000 or 50% of the balance of the account at the time of the violation (whichever is greater).

The IRS has created two amnesty programs to help you get caught up. The program most helpful to expats is the Streamlined Filing Procedures. This program is available to US citizens living in both the US and abroad and all who have failed to file due to lack of knowledge are eligible. To file under this program, you will file the last 3 years of Federal Tax Returns (if you haven’t already done so) as well as the last 6 years of FBARs. The FBAR filings will be done electronically, just as they would if you filed on time. It is extremely important that you get caught up if you are behind in your filings.

Tax Time is here…What changed, how will it impact your tax return?

Don’t you feel Income Taxes are the hardest subject in the world to understand? That is exactly what Albert Einstein said way back when: “The hardest thing in the world to understand is income taxes” – Albert Einstein.  Taxes have gotten more complicated since then – most are dazed and confused when it comes to their tax returns, so I thought it would be helpful to provide some insight on 2015 IRS Tax code and provide a quick reference guide for tax preparation.

General Tax Updates

Tax Bracket Adjustment – The 2015 tax bracket has been updated to reflect 1.6% increase factoring inflation. The top 1% of high income earners including individuals with over $413K in Taxable income will be paying out 39.6% income tax on their Gross Taxable Income.

Changes to Standard Deduction – The standard deduction amount has increased from prior year.

$6,300 for Single / Married Filing Separate Taxpayers

$12,600 for Married Filing Jointly

$9,250 for Head of Household

 

Alternative Minimum Tax – The alternative minimum tax was set to limit tax breaks for Americans looking to reduce their overall tax bill. As of 2015, the AMT income exemption for taking this tax break is set for individuals who earn over $53,600 and married filing jointly couples at $83,400 in taxable income.

 

2015 IRS tax brackets, standard deductions, and personal exemptions

Tax Rate Single Married/Joint & Widow(er) Married/Separate Head of Household
10% $1 – $9,225 $1 – $18,450 $1 – $9,225 $1 – $13,150
15% $9,226 – $37,450 $18,451 – $74,900 $9,226 – $37,450 $13,151 – $50,200
25% $37,451 – $90,750 $74,901 – $151,200 $37,451 – $75,600 $50,201 – $129,600
28% $90,751 – $189,300 $151,201 – $230,450 $75,601 – $115,225 $129,601 – $209,850
33% $189,301 – $411,500 $230,451 – $411,500 $115,226 – $205,750 $209,851 – $411,500
35% $411,501 – $413,200 $411,501 – $464,850 $205,751 – $232,425 $411,501 – $439,200
39.60% over $413,200 over $464,850 over $232,425 over $439,200
Standard Deduction $6,300 $12,600 $6,300 $9,250
Personal Exemption $4,000

 

Healthcare Tax Updates

 

Affordable Care Act (ACA) Penalty – The ACA penalty has increased in 2015. The fee for not having health coverage in 2015 is the greater of:

 

  • 2 percent of your yearly household income. (Only the amount of income above the tax filing threshold, about $10,150 for an individual, is used to calculate the penalty.) Or,
  • $325 per person, ($162.50 per child under 18). The maximum penalty per family using this method is $975.

 

Health Expense Account (HSAs & FSAs) changes – Individuals who have a Health Savings Account (HSA) in 2015, the contribution limit has been raised to $3,350 for the single plan and $6,650 for the family plan.

 

In addition, the Health Savings Account (HSA) has three major tax savings:

  • Contributions are tax deductible
  • Growth of the HSA (outside of contributions) are tax-free
  • Withdrawals are tax-free if used to pay for medical expenses

 

On the other side, for those individuals who opted to use a Flexible Spending Account (FSA), you will also receive an increase in the total contributions limit to equate to $2,550, up $50 from 2014 that is required to be spent in the 2015 plan year.

 

Retirement Plan Updates

 

401(K) Contribution Limits – In 2015, employees can now contribute up to $18,000, which is up from the $17,500 limit imposed in 2014. In addition to the increase in 401(k) contributions, there is also the increase in catch-up contributions for individuals who are age 50 or over at the end of the calendar year. For 2015, the total catch-up contributions equate to $6,000 per person and are allowed under a 401(k), 403(b), SARSEP, and governmental 457(b) plans.

 

Limitation on IRA rollovers – As of 2015, you are limited to one indirect rollover from your IRA account to another IRA account per year. With an indirect rollover, a plan participant is allowed to withdraw (through a distribution) all of their retirement balance without taking on a penalty if they decide to enroll the balance into a new IRA account. Due to the 2015 change, indirect rollovers are now only allowed to be performed once a year.

 

However, if you want to transfer your IRA balances through a direct rollover, i.e., trustee to trustee, then there are no limitations on how many times this can occur. As long as your retirement balance stays out of your hands during the transfer (i.e., direct rollover), you can perform this process as many times as you like.

 

The Saver’s Credit (Retirement Savings Contributions Credit) – Low and moderate income workers are provided an additional tax credit to help them save for retirement. According to the IRS, the saver’s credit helps offset part of the first $2,000 workers voluntarily contribute to IRAs and 401(k) plans and similar workplace retirement programs.

 

In 2015, the saver’s credit increased by $1,000 for married-filing-jointly couples who make less than $61,000. The credit was also increased by $500 for individual taxpayers with incomes less than $30,500.

 

Other 2015 Tax Changes

 

  • The personal exemption for Tax Year 2015 rises to $4,000.
  • The 2015 maximum Earned Income Credit amount is $6,242 for taxpayers filing jointly who have three or more qualifying children, up from a total of $6,143 for Tax Year 2014.
  • Estates of decedents who die during 2015 have a basic exclusion amount of $5,430,000, up from a total of $5,340,000 for estates of decedents who died in 2014.
  • Under the small business healthcare tax credit, the maximum credit is phased out based on the employer’s number of full-time equivalent employees in excess of 10 and the employer’s average annual wages in excess of $25,800 for Tax Year 2015, up from $25,400 for 2014.

Make a Wise Choice when Selecting a Tax Preparer

Tax Time is round the corner. In next two months a lot of taxpayers would be looking for a good preparer who can not only do their tax returns, but guide them and help them properly plan to save taxes. Now is the time to talk to a prospective tax preparer and sync up and share your tax situation for TY 2015. In tax season most of the preparers are busy and they work on stringent timelines as April 15 clock is clicking. It is very important that you make your decision wise as even though a tax preparer is preparing your taxes, you are responsible to ensure that all the information is included in your return.

Here are some tips that would help you select the right preparer.

  1. Ethics – Talk to the preparer and get an understanding of their ethics by knowing on how they would treat certain tax situations. Check on what measures they take to safe guard your data. Also if needed ask for 2-3 referrals of their existing clients who will share their experience working with the tax preparer.
  2. Fees – Do not ever pay a preparer % of refund as their compensation. Also avoid preparers who say they can get a larger refund than other preparers. Also ensure that the refund is deposited in to your bank account and not in to preparer’s account.
  3. Preparer Taxpayer Identification Number (PTIN) – Ensure that the preparer you select uses their PTIN on the tax returns they prepare. PTIN has to be renewed by tax preparers every year with the IRS and is mandatory to be used on the tax returns.
  4. Research Preparer’s History – For the status of Enrolled Agent’s license, check with IRS Office of Enrollment (Enrolled Agents are licensed by IRS and are specifically trained in federal tax planning, preparation and representation). For Certified Public Accountant, verify the state board of accountancy, for attorneys, check with the state bar association.
  5. E-Filing – Any paid preparer who prepares and files more than ten tax returns generally must file returns electronically.
  6. Tax Records – Good preparers will ask to see records and receipts. Do not use a preparer who is willing to e-file a return using the latest pay stub instead of Form W-2. This is against IRS-efile rules.
  7. Preparer availability after filing due date – This may be helpful if questions come up about the tax return or audit notices after the tax return has been filed.
  8. Review the tax returns and ask questions before signing – Taxpayers are responsible for what is on their tax returns, regardless of someone else prepared it. Make sure it is accurate before signing it.
  9. Never sign a blank tax return – If a taxpayer signs a blank return the preparer could then put anything they want on the return – even their own bank account number for the tax refund.
  10. Preparers must sign the return and include their PTIN – The preparer must also give the taxpayer a copy of the return.

Tax Return Preparer Credentials and Qualifications

Any tax professional with an IRS PTIN is authorized to prepare federal tax returns. However, tax professionals have different levels of education, expertise and skills.

An important difference in the types of practitioner is ‘representation rights’. Enrolled Agents, CPAs and Attorneys have unlimited representation rights before the IRS. Tax professionals with these credentials may represent their clients on any matters including audits, payment / collection issues, and appeals.

Who are Enrolled Agents? Why should I depend on them for my tax preparation and planning needs?

Enrolled Agents – Licensed by the IRS. Enrolled Agents are subject to suitability check and must pass a three-part Special Enrollment Exam, which is a comprehensive exam that requires them to demonstrate proficiency in Federal Tax Planning, Individual and Business Tax Preparation and Representation. They must complete 72 hours of continuing education every three years.

Call us today at 770.682.3119 for all your tax filing needs.