When Joe the Plumber confronted Obama about small business taxes, my first thought was that this guy doesn’t know enough about business income and expenses to run a small business properly. If this business makes more than $250,000 a year in profits and has employees, then it shouldn’t be set up as a sole proprietorship. At minimum, it should be a limited liability company. So for all of you who are concerned about small business taxes under Obama, here my quick guide to setting up an LLC.
How to Set Up an LLC
There are two basic ways to set up an LLC: 1. Hire a lawyer, and 2. Use an LLC filing service. Setting up an LLC is easier and cheaper with a filing service because all you have to do is fill out an online form and the service does the rest of the work.
Of course, if you have a large business or a complicated structure, then you should hire a lawyer because they can advise you about which business structure is best for you. An LLC is usually appropriate for a small business, but there are occasions where a corporation is a better option for you and your employees.
The Benefits of an LLC
An LLC offers two primary benefits: tax flexibility and a legal shield. If you have a business with employees or do business with the public, then a legal shield is vital. The tax benefits become important once your business starts to do well and you have to report large profits as personal income.
With an LLC, you can opt to have your company taxed as a corporation or choose pass-through taxation. With pass-through taxation, the profits (after expenses and deductions) is taxed as self-employment income on schedule C. If you have a large business with several employees, then you may want to elect to be taxed as a corporation. In this case, you would receive a wage and dividends and would be personally taxed on the income from those sources, however the corporation is also subject to a separate corporate tax. On the other hand, corporations can deduct more expenses, which could reduce the profits to a taxable amount lower than it would be as personal income. Consult your tax preparer or accountant before choosing your designation to determine which is best for your business
Benefits are often a deciding factor in this issue. If you operate as an LLC, then health benefits, parking, and other benefits for you and your employees are taxed as income. Benefits you and your employees receive from a corporation are not taxed.
A legal shield is even more important than the tax flexibility an LLC offers. LLC means “limited liability company,” and it does exactly that. When you operate under this structure, your personal assets are protected from lawsuits against your company or creditors if your company goes bankrupt. In our litigious society, that’s a very important protection. Many small business owners have lost their homes and businesses to a lawsuit because they were operating as sole proprietorships.
When setting up an LLC, consult with an accountant to ensure that your personal and business records and accounts are kept separate. If the funds or assets are mingled, a lawsuit may be able to pierce the legal shield.
Most small businesses don’t earn more than $250,000 or have employees for whom benefits are an issue, but you should strongly consider a more formal business structure as your business grows. Even if Obama doesn’t raise taxes on incomes over $250,000, the benefits of protecting your business and assets far outweigh the costs of setting up the LLC.