Nutritious and Delicious: CPA Tax Conversation
He is the CFO of several small companies, and was very easy to understand on the phone. He's also a certified financial planner, which will come in handy in all of this.
Don't take any of the following as his advice (or mine); it's my imperfect recollections of the things that were most salient to me. I could even have things below absolutely backwards.
We had an hour and a half conversation today encompassing several things:
-The tax treatment/behavior I needed to get be a 1099 contractor for my current client. A C or S corp tax status along with several other behaviors of mine will guarentee I can be a 1099 employee under the IRS 20 questions about W-2/1099 employees. Ironically, the creation of the corporation would probably make me change the last few behaviors that made the 20 questions iffy as a sole-proprietorship
-The way mileage deductions work (to go to the site of my current major client, I have a 39 mi round trip, so this is important).
-How taxes are treated in S-Corps/C-Corps/Disregarded LLC
-How you introduce assets into the company (a fair value, so a used laptop is not going to be valued at the price you bought it at, even if the company still sells it at that price)
-What my hourly costs would be if I didn't ever produce a product but just paid for labor for contracting clients.
-What's a good business expense, and what's a shady, asking-for-an-audit expense. [I was continually amused how "non-aggressive" I was in things I was interested in expensing]
So the public service portion of this post will be a re-explanation by me of the 3 choices you have for your LLC tax treatment.
First off, when its time to do real business (ie, open a bank account), you need to file a SS-4 (with the IRS). The IRS will then give you a EIN, the company version of a social security number. Beware, this starts a clock. Until you do this, the company you form lies dormant. Filing SS-4 puts a timetable on the 8832 and 2553 elections explained below.
1. You can do nothing, and it will be treated as a sole proprietorship/partnership (depending on number of members) for the sake of taxation.
Profits flow through on the 1040 C of the owner's return
All profits that flow through are taken as pay, so you pay Social Security and Medicare and Unemployment on them.
2. You can elect to be treated as a corporation (a c-corp) on form 8832.
Your profits will be taxed at a corporate tax rate by the federal and state gov't. If you release profits to the owners (which you do *not* have to do), they are taxed at the owner's rate.
There are incredible loss retention capabilities in this type of tax treatment. If you lose money in a given year, and you made money in the one or both of the prior two years, you can amend the last two years to get the tax paid on those profits back. You can also retain losses in a C-Corp for up to 15 years.
I didn't note the exact timetable here, but I think I read this was "Before you file a 2553, and before/when you file your first year's taxes".
You can also set your fiscal year to be something other than the calendar year if you're a C-Corp. This is key for government contractors (the US Gov't fiscal year runs from 1 October - 30 September) who have reporting requirements along the government's fiscal year.
3. After electing for a C-Corp with form 8832 (option 2a), you can file a 2553 within 75-days of the SS-4 filing to become an S-Corp.
With an S-Corp, active members need to take a salary. This will be taxed with Social Security and withholding and Medicare and unemployment. However, all profits/losses left in the S-Corp at the end of the year are added to the owner's adjusted gross income. This means as an owner, you're going to get the profits and losses of the S-Corp against your own income. This portion is *not* taxed by social security and its ilk. (See the tax advantage over the disregarded LCC?)
With an S-Corp, you have a couple strictures. Major ones include, you can't have non-US investors, you can't have more than 100 members, you can't have C-Corps as members and you can't have more than 1 type of stock. There are surely more.
You can revoke a S-Corp election with a simple letter to the IRS. Beware though, you can't re-elect to be an S-Corp again for 5 years. There used to be a lot of "perq" restrictions on S-Corp owners. These may or may not have eased recently, especially medical exceptions. The common consensus seems to be that perqs alone aren't enough to offset the double taxation.
Now, what's the thing for me?
Well, 82% of businesses run by first time entrepreneurs (that's me) fail, I should possibly look at the C-Corp long and hard. Also, I'm thinking about making this a lifetime investment vehicle for my job of the moment. In that case, the wealth retention aspect of the C-Corp might be better.
As I can get out of S-Corp status relatively easy (write a letter to the IRS), I should very possibly just go that route until I am sure I at least have the possibility of a big loss.
I'll let you know which of the two options I chose. I'm glad to get the tax questions out of the way so I can cost out rates and figure out other basic financial issues confronting me so I can get back over to the actual business of the business rather than the sideshow of taxes and costs.