I hope your business had a fantastic 2019! Now is the time to implement planning for 2020.
At the top of the list: whether your business should incorporate or become an LLC for the next tax year.
December is the perfect time to look at this. You can make January 1 the effective date for your new entity. You will have a clean accounting start for the new year.
As your small business grows and evolves, it may make sense to consider changing its structure. Many small businesses start out as sole proprietorships or partnerships, with only one or two owners and no employees. Over time, your business grows and changes. A more complex business structure may become beneficial.
Here are a few key considerations in deciding whether your business should incorporate or become an LLC for the next tax year
As a sole proprietorship, your profit “passes through” to you individually, to be reported on your personal income tax as income. You also pay self-employment tax on this profit.
Depending on how much your profit was this year, it may make sense to incorporate. By doing so, you can pay yourself a reasonable salary and take payroll deductions for your FICA and Medicare. Your salary is then a deductible business expense, lowering the amount of profit on which you pay personal income tax.
If your small business has hired employees, taken out loans, or provided products or services to customers, you, as the owner of the business, may be exposed to extensive personal liability for business-related damages in lawsuits against the business unless you have selected a business entity that limits potential liability to business assets. In an LLC, for example, members can only lose the amount they have invested in the LLC, and they are generally not liable for business debts or obligations.
If you have been a sole proprietor, but now want to add one or more business partners, it is beneficial to formalize the arrangement by entering into an operating agreement that clearly spells out everyone’s rights and obligations.
Banks often prefer to give loans to businesses that have opted for a more complex business structure, seeing them as less risky. If you are planning on seeking a loan, it may be advantageous to invest in the effort required to adopt a more formal structure. Investors also often prefer business structures that minimize their risk. For example, in a limited partnership, limited partners, who have invested money in the business but have a minimal role in its day-to-day operations, are not liable for business debts or obligations.
To get you started, I file articles of incorporation for a corporation or articles of organization for an LLC with the California Secretary of State. For a January 1 effective date, we can get everything on file in December.
Then, we create the corporate or LLC documents that show you are respecting the separate nature of the new entity. A sole proprietorship is not separate from you individually, that is, business assets and liabilities are not considered to be separate from the owners’ personal assets and liabilities. However, the corporation or the LLC is a new entity, owns the business’s assets and liabilities, and has its own tax i.d. number.
For a corporation, we create bylaws and minutes, which will designate officers (one person can be all of the officers), and give the corporation authority to conduct business and open a bank account.
Each business has its own unique circumstances to consider. Don’t go it alone. We are here to discuss how to properly structure, form, and protect your business, whether you choose to LLC or incorporate. https://www.decarlilaw.com/practice-areas/business-law/
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