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Do You Have the Right Business Structure For Where Your Business Is Now?

Jan 29, 2008
With so many baby boomers retiring or quickly approaching the time where they'd like to, and seeking a way out of the rat race, there is a glutton of information suddenly available about starting a home-based or internet business. One of the leading benefits promoted is the tax deductions and other advantages available to business owners. However, it is critical that you are in the right business structure for your unique situation to truly take advantage of those benefits.

Recently a leading and highly respected tax strategist and CPA met with a bunch of her fellow CPA cohorts to discuss common problems they saw their clients facing with their taxes and believe it or not, one of the main issues was having the wrong business structure in place. In other words, their clients were operating their business in the wrong structure for where their business was at that moment in time. And the problem was that despite these CPA's best efforts it was costing their clients a bundle in unnecessary taxes at tax time. And a few were at risk of losing everything.

We've all met those folks, who "just have a little 'ole teeny business, they don't think they need to worry about taking measures to protect, until it's too late". They make a mistake and get taken to the cleaners.

Now, if you've been reading my newsletter for any length of time, you already know not to use a sole proprietorship or general partnership to operate your business. But what about the other business entities? How do you know which one is right for where your business is right now?

So, you know I have to preface this by saying, it depends very much on your particular situation and you should consult your individual advisors to determine what's best for you. However, having said that, I will also say that for most U.S. business start-ups by U.S. residents there are really only two ways to go:

The first is an "S" Corporation. The second is an LLC (Limited Liability Company) that elects to be taxed as an "S" Corporation.

I recommend these two options because very few businesses, home-based or otherwise, start out making any taxable income from day one and many businesses may even lose money for the first year or longer, even companies that may eventually become giants in their fields like "Google" and "Amazon". Even those business that do actually generate income from day one, in this stage of your business, if you have a good tax advisor, you are just beginning to find and take advantage of all those wonderful new tax deductions you now get to write-off on your taxes.

Oftentimes, we get so overloaded with stories of easy, make money while you sleep, get-rich-quick schemes, and overnight successes that here, in the US, we have a tendency to expect to make money from day one in our businesses, and then give up on the business when we discover we can't do that.

The problem with this type of thinking is that it doesn't allow us to plan realistically for our success, which means we don't give our advisors the right information to help us form the proper business structures for where we are and often times end up actually hurting our efforts to create success. This is critical when it comes to using your business to build wealth, because reducing your taxes to create money to invest is a key element to making that strategy work.

So how realistic are your projections? If you're just starting out and you've painted wonderful pictures of huge profits for your business for your advisors, or just left them to guess, you're probably going to get a business structure for that type of business. Now here's the problem, that's probably going to be a "C" Corporation, which is great if it all really goes that way. But, suppose it doesn't? Suppose it goes like most start-ups do and doesn't make a lot of money or even loses money and you have to keep working on the side and putting money into it?

That's where "the problem" kicks in, because in a "C" Corporation there is no tax benefit to you. You don't get to take a deduction for all the money you've put into the business, or any of its losses, plus if you've personally earned income, either as salary from the business or otherwise, you now have to report and pay taxes on that income, even though your business is losing money and you're supplementing its existence.

If you had planned for this possibility, and used the "S" Corporation, then you could have applied all those deductions to your personal tax return and used them to offset your income from the business or other sources, like a 9-5 job. Plus with an "S" Corporation you minimize the 15.3% self-employment tax, protect your personal assets from business activities that go astray, and get maximum flexibility as you learn how to work with your business and discover all the new deductions available to you.

You've Survived Start-Up ... Now What?

You stuck with it and now your business is starting to make money. Not just a few hundred dollars or a thousand bucks now & then kind of money. But serious, consistent income you can count on. You're probably still a one-man or woman show, maybe a few independent contractors, now what do you do? Again, it depends on your particular circumstances, you don't want to jump to a "C" Corporation to soon, or set-up other structures that you don't need. But you definitely want to revisit the whole business structure question.

Are you still operating in the entity type that's best for you? Do you need to have other business structures in place to continue to maximize your tax reduction strategies? For example suppose you decided to branch out to invest some of your money into long- term real estate holdings. Now you would want to add an LLC or possibly a Land-Trust to your business structures and preferably, one for each piece of property you hold.

You also want to take another look at your tax deductions, are you getting everything, are there new areas where you may be able to take a deduction where maybe you didn't qualify before, or that you overlooked? Look at everything you're spending money on and ask yourself "how can this be made into a valid deductible expense?" Remember the key, use the guideline: is it ordinary and necessary to the production of income for your business. Not everything you're spending money on will past the test, but you may be surprised at how much of your ordinary expenses can.

Also, at this stage as the money starts to build up begin to look into and think about maximizing your pension plan. If you don't have one, you can start now. There are all kinds of things out there now, traditional and Roth IRAs, Sep IRA, Solo 401ks and they even have a Roth 401k now and you even get to choose between self-directed or regular plans.

Of course there are qualifications to all of this stuff you'll need to discuss with your personal advisors, but the great thing is with these plans you either get a tax deferment now, or tax free income for life later, plus you'll be putting yourself in position for the next level of your business where you can take advantage of more advanced strategies.

Playing In The Big Leagues

In the U.S. Small business is actually defined as a business that makes under $50,000,000.00 per year. No, that's not a misprint. Many companies you think of as huge are actually considered small businesses. You may not be at that level, especially if you want to maintain a small home-based business. But, you can still grow your business pretty large.

As your business moves into this stage, it's very important for you to have good advisors around you, especially a CPA that's a proven tax strategist and an attorney that's familiar with the strategic use of business structures to create wealth and provide asset protection and has the ability to communicate effectively with your CPA & vice versa.

This is the stage of your business where your use of business structures will be the most complicated, you will most definitely find that you will need more than one and in some cases several to minimize your earned income and really maximize your tax deductions. It is also the stage of your business where you will have the most opportunities to put multiple tax strategies into play that can let you live virtually tax free. Legally; this is where you truly begin to discover the true wealth building power of having your own business.

There are two reasons why you set up a business structure:

(1) To pay less in taxes and
(2) To protect your assets.

There are literally hundreds of tax deductions available once you start a business or start investing in real estate. However, in order to take full advantage of them you have to be in the right structure for your business, where it is now. Otherwise, you will probably end up paying more taxes than you should and sabotaging your efforts to build wealth.
About the Author
Ranju is assistant to Pam Hamilton is the home business coach. Her company, http://www.build-a-biz.com/optinpage.html helps entrepreneurs and small business owners create and grow their business to build wealth, minimize taxes and protect their assets.
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