THE FISCAL BLUE PRINT
WITH COACH JEFF MONTGOMERY
Episode 28: Legal Structures for Setting Up Your Own Business
Are you thinking about starting a business in 2020? Maybe you’ve had an idea for a long time and now you feel like you are finally ready to implement that idea. Maybe you recently retired from your field of expertise and are thinking about starting your own consulting business.
How you decide to structure your business is critical and can affect all kinds of things from taxes on your profits, potential lawsuits, succession planning, to even what type of account your bank will let you open to handle the business affairs.
Structure your business the wrong way and you could end of paying more taxes than necessary and open yourself up to the risk of a potential lawsuit that could jeopardize your home and other personal assets.
If your 2020 goal is to start your very own business, lets start out the year by discussing the best legal structure for you.
Disclaimer: Please do not take advice from me on this show. As a licensed Fiduciary I am only allowed to give advice to clients. So, unless you’re a client I can’t give you advice because I don’t know you. So, think of this as helpful hints and education only. And please before implementing any information or ideas you hear on this show always consult your legal adviser, your tax adviser, and your financial adviser…………. right? that’s just common sense.
(2:00) Practical planning segment: We have a special 4-part series discussing legal structures to consider when starting a new business. It may not sound like the most fun topic to discuss and some maybe be wondering why were even talking about this on The Fiscal Blueprint podcast because we usually tackle retirement planning subjects
Well I have noticed a recent trend in our practice and many of the soon to be or already retired folks don’t………………… really want to retire in the traditional sense.
Now don’t get me wrong……………. the majority still do! They are DONE with work and are ready to travel, build that 2nd home, spend time with the kids and grandkids, volunteer, play pickleball, etc. However, I also notice quite a few starting 2nd careers and many of those second careers involve starting a business.
We have folks that are turning their hobbies into businesses that can earn a profit or more commonly we have folks that retired from a particular industry with a very high level of expertise and create their own consulting businesses
SO, in each episode we are going to talk about a certain business structure and with each structure we’ll give an overview, talk about taxes and how they are handled with each structure, and the liability you may face with each structure.
(5:00) The 4 basic types of legal structures are; Sole proprietorships, Partnerships, LLC’s and Corporations (S-Corp and C-Corp’s.
Today were going to talk about Sole Proprietorships. This is by far the simplest type of structure. From the Federal governments perspective all you must do to form a sole proprietorship is to start doing business.
Any business that’s is started by a single person is automatically a sole proprietorship unless the owner decides to form some other type of entity.
Now you may have noticed I emphasized from the FEDERAL government’s perspective. You can almost bet from your local government, state, county’s perspective they will most surely want some type of other requirement be fulfilled in order to do business in that location
That requirement would typically be in the form of money by way of a licensing fee in order to obtain a business license. They would want to know what type of business you are starting, and different business may require very different licenses such as restaurants, contractors, realtors, etc.
EIN Number… Do you need one? For a sole proprietorship you don’t need one, but you can still get one.
If you plan on doing business under a name other than your own, you’ll also need a DBA (Doing Business As). The reason for a DBA is for accountability purposes. If the sole proprietorship breaks the law, they would need to trace it back to a name on file.
Example: Let’s say you hired “ABC construction Co” to build a new Deck on your home and the deck failed and injured someone. The company name cannot be sued because it’s a sole proprietorship and without the DBA on file there would be no record of the owner. More on this later.
(9:00) Taxation: Sole Proprietorships are known as pass-through entities”. As name implies is that profit and loss is passed through to the owner. The profit will show up on tax form 1040
Schedule C would be the form where you calculate the profit or loss from the business. The bottom-line number on the schedule C is known as you Net profit or Loss which is carried over to your 1040 and less your deductions your taxable income would remain and be taxed at your individual tax rates as SINGLE OR MFJ
That’s regular income tax, right? Any other types of taxes to be concerned about? Yes, in addition to reg income taxes you as a sole prop you are also subject to self-employment tax
This is calculated on schedule SE by multiplying your net earnings which is slightly less than your net profit (to be exact its 92.3% of your net profit) by 15.3%
It may seem unfair to have to pay another 15.3% just because your self-employed but SE tax is just like social security and Medicare taxes that are paid on wages for non-self-employed people. The difference is when you work for an employer you split the 15.3%. When you SE there is no employer to split it with so it’s all on you.
Also, when you run a sole prop you do get to deduct ½ of the SE tax you pay on schedule 1 of form 1040. So, I guess congress thought about that as unfair as well and decided to create a tax deduction when calc your gross income.
There is one other possible deduction for Sole P’s. for tax years 2018 to 2025 to reduce your taxable income, it’s called the pass-through deduction and is equal to 20% of your income from the pass-through business. Not all business qualify and there are also income thresholds to be aware of as well. Definitely consult your tax advisor on those thresholds and to see if your business qualifies for that additional 20%!
(15:45) Liability: The major downside to the Sole Proprietorship structure is that the proprietor is personally liable for all debts of the business. This is known as UNLIMITED LIABILITY”
If anyone has a reason to sue your business, they can come after all your personal assets not just the money you have in the business checking account. If the suit is large enough you could end up losing all of your personal possessions…………. savings, car, home, etc.
That’s pretty scary, and that’s why most people start to research other forms of business structures. Before you do that, think about the worst-case scenario for your type of business. Whether you provide a product or a service, what is the worst possible outcome if everything goes wrong? For example: If you are an author that writes fiction you probably don’t have much liability compared to a construction co or electrical contractor if everything goes wrong.
(18:00) Coachable Segment: In our coachable segment today Let’s run through everything we just learned in a quick summary:
- Any single owner business will be a Sole P unless the owner takes an explicit action such as incorporating
- The Fed govt doesn’t require you to file any documents to form a SP
- Your local govt, City, State, County may require you to get a license
- Many state and counties require you to file a DBA if you plan to use a name other than your legal name
- SP are known as pass through entities for tax purposes
- The P&L from a SP is calc on schedule C
- Earnings from a SP are subject to Self-Employment tax at 15.3% (2.9% above the annual max for SS)
- You will get a deduction for ½ of your SE tax reported on schedule 1 of your 1040
- For 2018 to 2025 you may be eligible for a 20% pass-through deduction. Check with your tax advisor
- SP have unlimited liability for any debts against the business
- Depending on the nature of your business unlimited liability sounds scary but may not be a big deal
“We appreciate you joining us today for this episode of The Fiscal Blueprint.
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