[atria]

If you don't know the basics, how to do you know when your accountant or bookkeeper is making a mistake, or giving you bad advice? How to do you know if they are optimizing their advice to make their jobs easier, not yours?

I stared an LLC last year. It it took two months to find an anchor client, and they started paying net 60 (so no income for four months). Compared to the year previous, my income effectively dropped 25%. The accountant figured estimated payments that would require me to pay every penny I made during the first half of the year. That would mean 6 months without income. He was simply taking last year's tax obligation dividing it by the number of quarters left, not the actual tax obligation. Did I mention he talked me into an LLC because the administration was simpler? He forgot to mention how much more in taxes I would be paying compared to an S Corp.

I'm now reading every tax book I can get my hands on, and am reading accounting textbooks. No one will watch out for your money like you should.

[tryitnow]

That's the problem with hiring any professional, you've got to do the homework yourself to (1) be able to communicate effectively with the professional and (2) make sure the advice you're getting makes sense.

This is true for all professions, doctor, lawyers, accountants, etc.

[chuinard]

Doesn't Yelp for doctors, lawyers, accountants, etc solve this problem?

[tempestn]

My sarcasm detector may be broken, but in short, no. Even a "good" professional can give bad advice. I love my accountant, but I still catch things he's missed occasionally. (And he catches things I've missed more often.) It's a partnership. Unless you're a mega-corp with in-house professionals, you're always going to know your business better than your accountant/lawyer/etc., and you're always going to care at least somewhat more than them too.

[iolothebard]

Nolo books are really good in my opinion.

I got a degree in Finance so I'd know what to do if I ever made money :-)

Looking back it seemed overkill, but maybe it wasn't. S-Corp has it's disadvantages as well (essentially requiring a salary, etc) and can't do things a C-Corp can (plus you have to wait for it to get accepted, which depending on when you start and file, can screw a year's returns up). I've had all 3. LLC is by far the easiest and probably the right choice 95% of the time IMO.

[mindcrime]

FWIW, an LLC can elect to be taxed as an S-corp.

[atria]

Unless you cannot, because you aren't in the allotted time window. Can distributions be treated as dividends?

[mindcrime]

Unless you cannot, because you aren't in the allotted time window.

Yes, there are rules around the whole thing. But, in principle, it is possible to have an "S LLC". But this kind of stuff is exactly where it's important to have good / knowledgeable advisors to help with this kind of stuff, because what average mortal understands the myriad of byzantine IRS regulations?

Can distributions be treated as dividends?

No idea. :-(

[icedchai]

I'm curious: How are the taxes between an S Corp and a single-person LLC any different? In both cases the income passes through to the owners, right?

[kjurka]

S-Corps can split payouts to the owner into wages and dividends while all LLC income is equivalent to wages. Wages are subject to social security and medicare taxes that dividends are not.

[icedchai]

I think you mean distributions (S Corp), not dividends (C corp), but I get your point.

[cstejerean]

How are you paying more in taxes for an LLC compared to an S Corp?

[cullenking]

The other two replies are incorrect (I have up until this year run our business as an S-Corp).

With an S-Corp, you pay your owners a reasonable salary. $50-70k is reasonable for our field according to our CPA. Any profits or losses from the business pass through to your personal income tax via a Schedule K1. The profits are taxed like normal income, they are not taxed as capital gains.

The tax savings come from the fact that the distributions you draw from the profits of the company are not subject to FICA (medicare, social security). This saves you upwards of 13%.

If you draw more than your profits for the year (say you run an accrual method of accounting, not cash, so you recognize revenue after services have been fully rendered, rather than when the cash comes in and you can have a large bank balance but no profit for that year), the excess is essentially double taxed with capital gains. A painful mistake, so track your AAA appropriately :)

[atria]

Interesting. When I ran my S Corp, my goal was to avoid estimated tax payments. At the end of the year, the accountant would calculate the required taxes and I would issue a "net zero" check that only paid taxes, or a bonus check with a enormous withholding. The remainder was taken out as a dividend.

Taxes paid via withholding are treated as if they are paid in through the course of the year which avoids estimated tax payment penalties.

[cullenking]

Yeah, I just do the quarterly estimated payments. If your business is constant (not growing) it's easy to handle via extra withholdings. If you are growing, they at least make it easy so that if you pay an estimated tax that matches the prior years tax owed (paid quarterly) you avoid any penalties, even if you have to make a lump payment to settle up the difference when you do your taxes at the end of the year.

We have a pretty sophisticated business intelligence platform written in R that gets us estimated revenues within 10%, so I know how to budget through the year for taxes owed. I just pay my known quarterlies and keep enough in the bank to handle the remainder at year end.

[delinka]

I'm certainly willing to concede that I'm wrong (I'm by no means an expert), but your advice is counter to what I've received from professionals. I'm curious whether you've run into this problem with others in the accounting, law, or tax professions and why the misconception (that I hold) exists.

[cullenking]

The problems I have run into have been acting like I know more than I actually do. Our first accountant assumed I knew everything since I acted like I was making informed decisions, which led to some issues. He also made a few mistakes (not capitalizing on section 179 one year for example).

In regard to your question about why your misconception is common, no idea. Just a quick google shows lots of accurate descriptions of the benefits of an S-Corp. Maybe a misunderstanding with your accountants?

After moving to a larger (and much more expensive) accounting firm, and learning from our previous mistakes, I've had a much more pleasant time dealing with this stuff. It's all arcane and stupid when it comes down to it, but you have to learn it to effectively manage your tax burden. If you don't actively think about it you get absolutely screwed on occasion, as it affects everything about your business. And the mistakes get expensive as your revenue scales up.

This is getting totally tangential, but you can probably hardly imagine all the crazy rules regarding taxation in the case of a sales event. Operating as an S-Corp is fine and dandy, but creates an additional hurdle for getting investment and for sales. S-Corps can only be owned by individuals, so an acquisition or an investment means restructuring, but you are restructuring after a planned purchase, which says certain things about intent which makes the restructuring likely a taxable event in and of itself.

I strongly strongly strongly recommend talking to an experienced business lawyer, and having them recommend an experienced business tax planner. This isn't schemey tax avoidance stuff, this is fundamental planning so you don't get a surprise $200k bill at some point!

[delinka]

A quick Google search gives me this from the first result[1]:

"Then, any remaining profits from the company can be distributed to the owners as dividends, which are taxed at a lower rate than income."

Though it doesn't specify what that rate is. Most of the other results indicate that the additional distributions beyond salary simply avoid self-employment tax. So it would appear that distributions beyond salary incur less tax, but are taxed higher than the current capital gains tax rate. It's also important to note that distributions are taxed - if you leave the money in the company, it's not taxed until it's actually distributed to the owners.

1 - http://www.inc.com/guides/201103/s-corp-vs-llc.html

[cullenking]

Again incorrect, all company profits are taxed regardless of whether you withdraw it in the form of distributions. If you withdraw distributions in excess of your basis (your share of accumulated profits/losses in the company, it can be negative or 0) then yes the distributions you take above your basis are then taxed as capital gains. Don't do that. I strongly advise finding a reliable, recommended professional to talk to about this stuff. We found a fantastic guy through our business lawyer, wish we would have found him earlier.

[iolothebard]

179 is the best thing in the history of tax law IMO. :-)

[soaponarope]

In an LLC all income is passed through to the owner(s) personal tax returns. An S Corp will pay the officer(s) a reasonable salary and an excess capital is return to owners through a dividend which is taxed a lower rate than normal income. All gains by the LLC pass through as normal income.

[hsitz]

No, the non-salary income is not "qualified dividends" and does not qualify for the 15% rate. It is taxed as "ordinary income", just like the salary. The advantage of S-Corp taxes has nothing to do with lower tax rates. It has to do with fact that FICA and Medicare taxes are taken out only from the portion of income designated as "salary". So you effectively save about 15% (i.e., the rate of FICA/Medicare withholding) for income that is above your salary to point where FICA/Medicare is phased out (around $100k).

Also others are correct in saying that an LLC can elect to be taxed as an S-Corp. S-Corp is a concept in the tax code, not a form of ownership itself. That is, if you create a corporation with the state, that corporation is just a "corporation", not an S-Corp or a C-Corp. Your corporation will be classified as an S-Corp or C-Corp depending on how you elect to file taxes with the IRS. It's similar with an LLC, which you create with the state, then can elect what tax treatment you will use with IRS: typically as sole proprietorship, partnership, or S-Corp.

[jazzyk]

This is incorrect, at least for for an S Corp. The rest of the money (after you pay salaries AND deduct valid business expenses) is distributed to shareholder(s) as shareholder distributions using Schedule K-1, not dividend (terminology is important, they are not one and the same).

Shareholder distributions then add (or subtract if you lost money) to/from shareholder individual incomes. It is taxed at the same level as other income.

[zrail]

One important point that people tend to ignore/forget: every dime of income after salaries and expenses counts as a distribution for tax purposes, even if the money stays in the company bank account. Shareholder/member distributions are not taxable events.

[delinka]

The S Corp pays you a "reasonable income" which gets taxed as income (withholdings, FICA, etc) and the remainder of the corporations profits that's passed on to the owner is taxed as capital gains (%15, IIRC).

With an LLC, all profits fall through to your income and is taxed as such.

Edit: revenue -> profit

[cullenking]

This is incorrect, the profits are not taxed as capital gains, see my above post. Only time you get taxed on profits as capital gains is when you make the mistake and take distributions in excess of your basis in the company, basically a rookie mistake, and then you get taxed cap gains on the amount in excess, and it's a double tax :(