Protect Your Personal Asset from Your Business Risks
Protect Your Personal Asset from Your Business Risks
Before the creation of Limited Liability Companies (LLC), your only option for protecting your personal assets from potential law suits as a result of business activities was to form a Corporation.
After forming the corporation, you could convert it to an S-Corporation by making an election with the IRS. Most business owners made the S-Election to avoid double taxation. Without the election, the corporation paid income tax on its net profit and monies distributed to the owners were taxed as dividends.
With a “regular” corporation (where the election was not made to become an S-Corporation), business owners could avoid the double taxation by paying out all the profits to the owners in the form of wages. Therefore, the corporation had no net income and paid no tax. The owners included their wages from the corporation on their personal tax returns.
In order to pay out all profits as wages at year end, this requires the corporation’s books and records to be complete by the last day of the year. This seems like an easy solution, but most businesses do not have their records up to date by December 31st.
To avoid double taxation, and the need to have their records completed by the last day of the year, most business owners chose the S-Corporation as their form of doing business. An S-Corporation, in general, pays no tax and the income and expenses of the corporation flow to the shareholders and is reported on their individual returns.
Another form of doing business is to operate as a partnership. However you do not insulate your personal assets from potential law suits from your business activities. The income and expenses of a partnership flow through to the partner’s tax returns in a similar manner as S-Corporations. Partnership taxation is, in general, more favorable than the tax treatment for corporations.
For a long time business owners were in a dilemma as to which type of entity to form to operate their business because there were advantages and disadvantages to each option. The resolution to this dilemma came with the creation of Limited Liability Companies (LLC).
An LLC is a corporation that has partnership taxation. It has the limited liability of a corporation and the favorable tax treatment of a partnership. An LLC files a partnership tax return.
However, because the IRS requires an LLC with only one member (partner) to file the same tax form as a sole proprietor, sole proprietors can now convert their sole-proprietorship to an LLC and not incur the added expense of having a separate tax return prepared. The only change is that the name of the LLC is on the schedule C, as opposed the their name, and it contains the federal identification number of the LLC. They simply continue filing a schedule C just like they did as a sole proprietor. The cost of their tax preparation does not increase, yet they have the comfort of knowing that they can separate their personal assets from the business activities.
As you can see there are many benefits to converting your sole proprietorship to an LLC.
If you have a specific question regarding this article, as a public service, and at no cost to you, I invite you to call me with your question. Since I am in the middle of tax season, I will have to limit our conversation. I will be happy to schedule an appointment for you if you would like further consultation regarding this, or any other matter. Thank you for your interest in reading my tax column.
This column is offered as a public service with the understanding that each person's tax situation is different; that you should consult your CPA before taking any action based upon comments made in this article. Call me and I will be happy to explain my “CPA Quality Tax Preparation at H&R Block Rates” and how you can decrease your tax preparation fees, or go to www.danghazel.com for more information. I can be reached at 540-825-2771.