A Business Life Cycle Approach to Entity Selection

This afternoon I was walking through a parking lot and saw this bumper sticker on a car.  “This slut votes.  My body, My choice.”   I don't care about your politics, but how many times have you seen a bumper sticker and thought, “OMG, I've never thought of that.  I'll change my opinion.  Thanks for sharing your genius with me.”  For me the number is a whole number between -1 and 1 exclusive.

I am certain of one thing, however, she (I assume she) is a slut.  Sensing opportunity, I walked completely around the car.  No luck.  There was no telephone number.  I'm just sayin'...  maybe my beloved Jen Aniston will be busy this weekend.

Most of the time in these posts, I try to provide a lot of background information.  That let's me get you up to where I need you to be to understand the topic of the post.  This time, however, I am just going to jump into my recommendations.  I have posted about entity selection before and explained the different types of entities.  Please review those posts first, if you find yourself a little lost.

If you are starting a small business, I recommend that you start out with a limited liability company (LLC).  If you are starting a professional services business like a law or engineering firm, you will use a professional limited liability company (PLLC).  LLC's and PLLC's are almost entirely identical from an income tax perspective.  If you are looking for a legal perspective, call an attorney.

The reason I recommend forming an LLC for your new business is that the LLC business entity doesn't  permanently lock you into any tax treatment.  An LLC is a chameleon.  It can be anything taxwise.

If you are starting out as a very small business, you can treat your LLC as a sole proprietorship for income tax purposes.  In tax speak, that means your LLC is a disregarded entity for tax purposes.  No separate tax return will be required for your LLC.  You get the limited liability protection of a corporation, but still get to keep the tax simplicity of a sole proprietorship. 

 If you have more than one owner, you can be taxed as a partnership, which does require a separate tax return.  Now you have all the advantages of a partnership for tax purposes, which include the ability to write distribution rules as you please and the ability to include personally guaranteed debt in your tax basis for deducting losses.  You also have the limited liability of a corporation.

When your business grows, you can elect to have your LLC treated as either an S corporation or a C corporation.  I rarely recommend C corporations for reason of double taxation.  However, you can save some significant money on Medicare taxes as an S corporation.  The time to consider making an S corporation election is when you annual profit nears $150K per owner.  An S corporation needs a separate tax return and must pay its owners a fair salary.  So there are additional costs to be an S corporation.  At about $150K profit per owner, the tax savings begin to exceed the costs.  The $150K isn't a hard and fast number.  It is just a good starting point to have the discussion about electing S corporation status.

As you can see, I have not covered all of the pros and cons of the various entity choices.  I have done some of this in previous posts and will cover more in future posts.

The key to choosing the tax treatment for your LLC is IRS form 8332.  This one page form tells the IRS the tax entity you are selecting for your LLC.  If you are a sole owner LLC, you don't need form 8332 to be treated as a sole proprietorship.  If you are a multi-owner LLC, you also don't need the form to be treated as a partnership.  However, the form is necessary to elect either S corporation or C corporation status for your LLC.  If you want S corporation status, there is one additional form to complete, form 2553.  Forms 8332 and 2553 are relatively easy forms to complete as IRS forms go.  Form 8332 is a one page form and form 2553 is a two page form.

The reason I recommend starting your business as an LLC is that the chameleon like LLC can growth with your business.  You can start out small and simply as a sole proprietor for income tax purposes.  Then as your business evolves, you can elect S corporation status.  Finally, if your business really takes off and you want to go public, you can change to a C corporation. 

As you can see, the choice to start out as an LLC is an easy one.  There are only a very few circumstances that would cause me to advise against starting out as an LLC.  Right off hand, I can't think of any.

The unsung heroes of the Redskins win over the Saints were the linebackers and defensive backs.  I won't pull a Smokin' Al Koken on you, and tell you I've been saying they were terrific for the last ten years.  I said they stink.  In fact, I think I said they stink like a dead fish wrapped in cow dung.  They stink like my neighbor's lawn after the dumb ass spread fresh manure all over it.  I was wrong.  Redskins linebacker, London Fletcher was covering the Saints' tight end so closely, Fletcher needed a condom.  If you are pondering the sexual meeting of tight end, get your mind out of the gutter.  Mine wasn't there.

Thanks for reading.  As always, for real tax and accounting advice, visit the main Stitely & Karstetter web site at www.skcpas.com.  Until next time, do it to them before they do it to you.