Through two decades of small business development in the public and private sector, I have learned that the legal structure of small business ventures revolves around the entrepreneur’s desire to protect his/her assets, while having the flexibility to direct revenue to one’s personal income with the least amount of expense, and avoiding a lot of paperwork. Until a few years ago, the “either – or” debate revolved around proprietorship vs. an S corporation. The introduction of the simple Limited Liability Company (LLC) changed that debate to either an LLC or S corporation. Again, the emphasis remains on liability, ease of accessing revenue for income and avoiding paperwork.
For the purpose of this column, please note that we are addressing the condition of self-employment with no employees, and for good reason. According to a Small Business Administration (SBA) report issued in December 2004, there has been phenomenal growth of self-employment. In the year 2000 there were 11.5 million non-agricultural ventures in the U.S. That grew to 12.2 million in 2003 of which 2.9 million businesses were unincorporated.
Liability
With the perception that we live in a “lawsuit happy” society, many entrepreneurs are no longer content to “roll the dice” and operate a proprietorship. The simple LLC has created the opportunity to bypass much of the initial and annual paperwork associated with incorporation. With some exceptions, the LLC shields the business owner from individual liability, including one’s personal assets. The S corporation provides the same general protections of the individual business owner from personal liability. However, the major distinction is that personal liability protection is limited only to the level of capital investment in the simple LLC.
Exposure to FICA
An especially taxing challenge during the start-up phase of a business venture is the need for the owner to access revenue for personal income while minimizing the related benefits and income tax expense.
The LLC allows the individual to capture revenue and direct it to his/her income without having to immediately set aside a portion for Social Security and Medicare (FICA) deductions. However, be advised that this does not relieve you of those federal benefits’ expenses. At the very best, you are simply delaying the obligatory payment of those federal benefits until the end of the year, when filing income tax returns. If you do end the year with a net profit posted to the Schedule C there will be an amount due equal to 12.4% (social security) on the first $90,000 in 2005 and 2.9% on all the net profit. The social security exposure rises to 12.4% on the first $94,200 in 2006.
The S corporation offers more flexible control of exposure to FICA taxes. In simple terms, the S corporation allows the owner to collect a certain percent of his/her total annual income in the form of dividend distributions, as opposed to a salary or wage. The rules of measure are not “set in stone” as to the percent of income that can be collected in the form of dividends, but the IRS indicates you must direct an amount of your income to salary or wage at a level equivalent to the amount typically earned by a person working in the particular industry. In other words, if you earn $50,000 in annual income as an auto mechanic in your own shop, and the average annual income for a mechanic in your geographic area is $35,000, then you are technically allowed to collect the remaining $15,000 in the form of dividends. This means you will pay income tax only on the dividends, whereas you pay FICA and income tax on the remaining $35,000.
Paperwork
There is no debating preference here. If minimizing paperwork is the highest priority then opt for the LLC. It does vary from state to state, but, for the most part, there is less paperwork for the LLC than the S corporation. For example, if you are self-employed and have no employees then your social security number will suffice for the Federal Employer Identification Number (FEIN). Secondly, your federal income taxes can continue to remain within the confines of the Schedule C, just like a proprietor. You do still have to file an annual report to the company’s state of residence, but there is reason to believe that may change. For example, the State of South Carolina eliminated the LLC annual report in 2004. On the other hand, Florida, California and many other states still require submittal of the annual report.
Still Have Questions & Concerns?
This column simply does not allow ample space to address all the details of liability, taxes and paperwork requirements associated with either of the two legal business structures addressed. And unfortunately, the treatment of LLCs and S corporations varies from state to state. Furthermore, there are many questions and concerns, beyond what is discussed in this column, that require attention. That is why I encourage you to access the MyCorporation.com website to learn more before deciding on the legal business structure to adopt:
Oh, and I strongly suggest you consider the MyCorporation online business formation services. Yes, the fee is slightly more than if you were to apply on your own. On the other hand, much time is saved, qualified personnel are fulfilling the application process for you, and all your individual and business needs are attended to throughout the process.
Sources:
MyCorporation.com at http://www.mycorporation.com/
U.S. Small Business Administration at http://www.sba.gov/advo/research/rs243tot.pdf
Internal Revenue Service at http://www.irs.gov/ and at http://www.irs.gov/pub/irs-pdf/fw9.pdf
State of South Carolina at http://www.scsos.com/corporations.htm
|
|
