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Ask The Experts: Entity Form
Read this article in PDF form here.
Q: My LLC business is finally kicking into high gear and things are going really well. Is there a ballpark figure of income (gross or net?) where it becomes more beneficial to reduce taxes to begin filing as a corporation instead?
A: Congratulations on your growing business and don’t forget that most of the new jobs and most of the economic growth in the United States come from small business owners just like you so keep up the good work. The easy answer to the question regarding the choice of entity form is that there is NO benefit from a tax standpoint to change to a corporation. At the end of the day, as a sole owner, all of the income will ultimately end up back on your personal income tax return at basically the same tax rates. There is an intuitive support for this other than pure math and tax code detail in that if there were an entity form that is better from a tax standpoint than any other form, then ALL businesses would be that form. So at the end of the day, the entity form will NOT have a material impact on your overall income tax liability.
There are certainly differences such as the ability to deduct health insurance costs, various employee benefit factors, and even how you as the owner are paid but there most like will NOT be a material difference in the overall income tax liability if the underlying economic factors are the same. In addition, the more complicated entity forms such as the corporate entity form are typically more expensive to maintain. Additional costs such as a separate income tax return, state filings, payroll costs, etc. will most likely be incurred. The reasons to choose an entity form other than operating as a sole proprietorship can still be important such as liability protection, going public someday, marketing reasons, adding a partner or other investors, etc. but the idea of changing entity forms solely to save taxes is kind of an urban legend.
Rather than spend time, money, and other resources considering a different entity form, spend those resources on your continued success. Make sure you keep good accounting records so that you don’t miss out on any deductions that you are entitled to. Be aggressive in searching for new deductions and more creative ways of saving those precious tax dollars. Find ways to reinvest your success in ways that create deductions such as new equipment or creating that next job to grow your business even further. Maybe that next job could even be an opportunity for your own child which could save thousands in tax dollars. And don’t forget about your own future. Maximize your investment in qualified retirement options such as an IRA or SEP to build your own nest egg and save some tax dollars at the same time. Again, and more important than anything else, congratulations and keep up the good work.