Episode Transcript
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Speaker 1 (00:01):
Welcome to the
Knowing what Counts podcast, the
place where expert guidancemeets smart financial decisions.
Whether you're a high net worthindividual or a thriving
business, the experts at MPCPAsare here to help you protect and
optimize your wealth.
Let's get started, becausesuccess begins with Knowing what
(00:22):
Counts.
Because success begins withknowing what counts.
Speaker 2 (00:26):
Your choice of
business entity can have a huge
impact on your tax liability andgrowth potential.
In this episode of Knowing whatCounts, we break down the pros
and cons of each structure andhelp you understand the
long-term financial implicationsof your decision.
Welcome back everyone.
I'm Sophia Yvette, co-hostslash producer, back in the
(00:49):
studio with Caitlin Henderson,tax senior associate at MPCPAs.
Caitlin, how's it going today?
I'm doing great.
How are you?
I'm also doing great.
So, caitlin, introduce yourselfto our listeners.
Tell them a little bit aboutyourself.
Speaker 3 (01:10):
Yeah, so as you
mentioned, I'm a tax senior here
at MPCPAs.
I've been with the firm forabout five years now and I've
gotten to work closely with bothclients and other managers and
partners in the firm on variousdifferent types of tax returns
and side projects anythingrelated to tax work.
Speaker 2 (01:33):
Thank you for sharing
that with us, caitlin.
Let's go ahead and get into ita bit more.
So everyone listening wants toknow which entity is right for
you and how do you decodebusiness structure decisions.
Now getting into the firstquestion here what are the first
steps to think about whenwanting to start a business?
Speaker 3 (01:57):
So, obviously,
starting a business comes with a
lot of questions, right?
There's a lot of things tothink about and it can sometimes
feel overwhelming at first.
So here are like a few helpfulhints that could help you when
you're getting started.
First thing would be to write abusiness plan.
It's like a description of yourcompany, includes a market
(02:20):
analysis, a marketing plan, andif you are looking for financing
or investors, they might lookfor something like this that
kind of lays out the ins andouts of how your business will
work.
Branching off of that financingyour business something to think
about.
Where will you get the money tostart your business?
(02:40):
It could be bank loans, sbaloans or maybe something private
, determining the legalstructure of your business,
which is what we're going to getinto later in this podcast.
There's a bunch of differenttypes of things that may work
better for you.
Some other things to thinkabout would be maybe registering
a business name or a doingbusiness as name, getting a tax
(03:05):
ID number and registering forstate and local taxes, depending
on where your business is goingto be located.
There is different requirementsfor each state, so it's
important to look into that aswell as depending on what your
business is going to be, you mayneed certain licenses or
(03:26):
permits, so important toconsider that, and if your
business is going to haveemployees, you want to make sure
you understand yourresponsibilities as an employer
before getting started.
Speaker 2 (03:39):
Now, what are the
main types of legal structures
to think about?
Speaker 3 (03:44):
All right.
So we're going to go throughfive different structures here
that you can consider.
So the first would be a soleproprietorship.
That is, when your business isjust you by yourself, no one
else involved, there's noseparate legal entity and you
may operate under a doingbusiness as name.
(04:04):
There's a partnership, which isa legal structure with two or
more people.
There's an LLC, which is alegal entity that's formed by
filing and articles oforganization with the state
you're located in and it isrequired to have an operating
agreement.
There's an S-corporation, whichis a corporation that elects to
(04:29):
be treated that way through theIRS Form 2553.
And what that does is it puts alimit on the number of
shareholders you can have at 100, where in a regular corporation
you can have unlimitedshareholders.
Where in a regular corporationyou can have unlimited
shareholders and yourshareholders in an S corporation
are limited to US residentindividuals, trusts and estates,
(04:52):
and you can only have one classof stock in an S corporation.
And then, finally, just acorporation.
A C corp is a separate businessentity that's organized under
state laws for whatever stateyou're located in.
It is completely distinct fromall its owners and it is run by
(05:15):
a board of directors officersand requires business
registration in your state.
Speaker 2 (05:23):
Now, what are the
advantages and disadvantages of
some of these entity structures?
Speaker 3 (05:30):
So each one has its
pros and cons, so we'll start
with the first one.
We talked about a soleproprietorship.
Some pros here are they're veryeasy to implement, they're low
cost and you have full controlover your decision making.
Since it's only you, we like torecommend to clients forming a
(05:51):
sole proprietorship that theyget a separate tax ID and bank
account just to keep yourbusiness related things separate
from your personal, but it'snot required.
Disadvantage to a soleproprietorship is that there is
high risk for legal liability,meaning that since it's just you
(06:12):
on your own and there's noseparate entity, everything you
own is subject to that liability.
Moving on to a partnership,some pros here they're
relatively easy to establish andthey're more flexible in
management and operationscompared to corporations.
When you have a partnership,you naturally have increased
(06:35):
capital available to you whenmore than one person is
investing compared to a soleproprietorship, and partners can
share the workload andresponsibility of the business,
which is definitely an advantage.
Some cons here would be thereis unlimited liability in a
partnership, meaning that eachpartner is personally liable for
(06:58):
the debts and obligations ofthe business, and there is also
a risk that if one partnerdecides they don't want to be
involved in the business anymore.
The partnership could dissolveand that could disrupt your
business.
Llcs are very similar topartnerships in their advantages
(07:19):
and disadvantages.
One thing that's a little moreappealing for an LLC is that
there is limited liabilityprotection from the partner's
personal assets unless they makea personal guarantee and LLCs
can be set up with only oneowner.
And there's also moreflexibility in LLCs with
(07:42):
distributions and allocatingincome or loss at
disproportionate amounts.
Some cons here they can be moreexpensive to set up than the
previous entities we talkedabout, and you can't pay
yourself through a W-2 in an LLC, which means you don't get
withholding on your income.
This can be surprising topeople at first when they're
(08:04):
setting up an LLC, so we alwayslike to point it out In an S
corporation.
Some advantages here are thatthey provide personal liability
protection to the shareholdersand, similar to the LLCs can be
set up with just one owner.
Some cons since it is its ownseparate entity, it can be
(08:26):
expensive to set up.
There's a lot that goes into it.
There's restrictions on thenumber and type of shareholders,
as we discussed earlier.
You are required to payreasonable compensation, which
means you would get paid througha w-2 here, but that can come
with more filings, more taxes,things like that, and there is
(08:48):
limited flexibility indistributions out of an S-Corp,
meaning that all income and lossneeds to be allocated pro rata
by ownership percentage.
And last thing here that couldbe a bit of a disadvantage is
that more regulations andformalities come with an S-Corp.
(09:11):
Things like annual filings,board meetings, issuing stock.
Those are all things that arerequired of an S-Corp and are
important to think about.
And then, lastly, for acorporation, some pros here.
They again provide personalliability protection to the
shareholders and there is alimited risk of loss, because
(09:33):
you can only lose what youinvested in a corporation.
A corporation itself can borrowmoney without a personal
guarantee and can generate itsfunds through sale of stock.
Some cons here would be verysimilar to the ones we discussed
for S-Corps in terms ofregulations and formalities that
(09:53):
come with them.
Speaker 2 (09:56):
Wow.
Now what are some of the othertax implications for these
structures?
Speaker 3 (10:04):
Yep, so each entity
has different tax filing
requirements.
A sole proprietorship actuallydoesn't have its own separate
filing.
So if you decided to go thatroute, all your income and loss
from your business would bereported through a Schedule C on
your personal tax return.
And it is important to notethat in this type of entity all
(10:29):
of your income would be subjectto self-employment tax.
Partnerships and LLCs arepretty similar for tax purposes.
The income still flows to yourindividual tax return and the
owners are taxed on all theincome from these entities,
regardless of any distributionsof money you take out of the
(10:52):
business.
Employees through these types ofentities are also paid by
guaranteed payment, which issubject to self-employment tax
rather than through a W-2.
And it's important to note herethat there still may be other
tax filing forms if you haveemployees in a partnership or
(11:12):
LLC.
That can vary depending on howyou've set things up.
S-corporations provide theadvantage compared to a regular
corporation that they are notsubject to double taxation and
they do not createself-employment tax.
We mentioned this brieflybefore that in an S-corporation
(11:35):
you pay yourself and employeesthrough a W-2, so you get
withholding on your wages, whichis an advantage for an
individual and For corporations.
(12:04):
The important thing to notehere is that there is something
called 1202 stock where there ispotential for a 100% gain
exclusion upon sale of theentity.
We do have a whole separatepodcast on this that you can
listen to to get more details onthat.
Speaker 2 (12:27):
Now, which structure
is the best?
Speaker 3 (12:31):
So this is a question
we get a lot from our clients
when they're looking to setsomething up, and the answer
really is it just depends on theclient and their type of
business.
Something that's alwaysimportant to consider is that
there is a legal side of thingsand a tax side of things, and
those may not always go in thesame direction.
(12:53):
So it's important tocommunicate with your CPA,
communicate with, maybe, anattorney or something like that,
and figure out what works bestfor you.
So maybe what is your risktolerance and what is your
desire to have more tax benefits?
That could alter your decision.
(13:14):
Some businesses may have morelitigious risk than others,
depending on the activity andthe business type, and so they
may need an entity that givesthem more protection.
And then it's also important toconsider what are your
long-term goals for the business.
Do you plan to sell thebusiness once it takes off?
(13:34):
That would have different taximplications and upon exiting,
that could depend on the type ofentity you have, how that gets
treated.
So that's important to consider.
And then, finally, do you needinvestors and the ability to
raise capital?
Then you might want to go witha corporation when setting up
(13:55):
your business, so that you havethe ability to do that.
So there's a lot of differentways to answer that question,
and it's more so a conversationthat you just have between
advisors and clients to figureout what suits them best
advisors and clients to figureout what suits them best.
Speaker 2 (14:18):
Now, what are some
pitfalls?
Speaker 3 (14:18):
What are some of the
pitfalls a lot of new business
owners tend to fall into.
There can be a few differentthings, so we want to highlight
some things here that maybe youcould avoid if we let you know
them ahead of time.
So first thing would be notplanning ahead.
You want to make sure you havethat business plan that we
discussed at the beginning.
Underestimating costs could gohand in hand with that.
(14:42):
If you don't have enoughcapital raised or financing to
support your business as it'staking off, that can be a
pitfall.
Your business as it's takingoff that can be a pitfall.
Not having good record keepingand financial management Maybe
something to consider is takinga bookkeeping course or hiring a
bookkeeper, if that suits yourbusiness better.
Not being knowledgeable onfinancial statements and basic
(15:07):
accounting it's important, atthe very least, to just have a
basic understanding of what thefinancial statements might look
like.
So maybe that is taking anaccounting course or looking at
some sort of education onlinethat could be provided to you.
And then one thing thateveryone should do or should not
(15:31):
do, is try to do everything ontheir own.
You want to find a goodattorney, find a good accountant
and maybe even a financialadvisor that can help you along
the way when you're starting upyour business well.
Speaker 2 (15:46):
thank you so much for
those helpful insights today,
cait.
We'll catch you in the nextepisode.
Have a fantastic rest of yourday.
Thanks, you too.
Speaker 1 (15:56):
Thanks for listening
to the Knowing what Counts
podcast.
Ready to optimize your wealthand protect your future, visit
thempgroupscpacom or call413-739-1800 to connect with our
team of experts.
Remember, success is aboutknowing what counts.