Entity Choice: Questions to Consider

“Should I form an LLC?”

It is a common question when starting a business. You may also hear that an S corporation could lower your taxes. But before choosing, it helps to know what each term means.

An entity is the legal form of a business. An LLC is one example. Your choice can affect taxes, paperwork, costs, and how the business is run.

A good place to start is with your own plans. Who will own the business? How much might it earn? Will it stay small or grow?

The questions below can help you prepare for a talk with your tax professional and attorney.

1. Who Will Own the Business?

Will you work alone or share the business with someone else?

If there will be more than one owner, discuss each person’s role early. One person may provide money. Another may do most of the daily work. Those roles may lead to different needs.

Ask:

• Who will make decisions?

• What will each owner put into the business?

• How will profits be shared?

• What happens if someone wants to leave?

Write down what you agree on. An attorney can help put those terms into the right legal documents.

Legal advice also helps you understand when you could be personally responsible for business debts. Taxes are only one part of this choice. Texas guide to business structures

2. How Will the Business Be Taxed?

The name of a business structure does not always tell you how it pays tax.

An LLC is formed under state law. S corporation status is a federal tax choice. An LLC may qualify to choose S corporation tax treatment. So “LLC or S corporation” is not always an either-or choice.

In general, unless another tax treatment is chosen:

• An LLC with one owner reports its income tax activity on the owner’s return.

• An LLC with two or more owners follows partnership tax rules.

Special rules can apply. IRS guide to LLC taxes

Ask your tax professional which returns would be needed and how the income would be taxed.

Also ask whether you need to make a formal tax choice with the IRS. This is called an election. It can have a deadline. Forming an LLC with the state does not, by itself, make an S corporation election.

3. How Will You Pay Yourself?

You may own the business, but that does not mean every payment to you is treated the same way.

Depending on the tax setup, you might take an owner’s draw, receive wages, or receive a distribution. A distribution is money paid to you as an owner.

For an S corporation, an owner who works in the business generally needs reasonable wages for that work before taking non-wage distributions. The pay should reflect the work done. It cannot simply be set low to reduce payroll taxes. IRS guidance on owner pay

Before choosing, ask:

• Will I need to run payroll?

• How will my pay be set?

• What records should I keep?

• How will slow months affect payments to me?

A plan needs to fit the rules and the cash available.

4. What Will It Cost Each Year?

A low setup fee does not tell you the full cost of running a business.

Some choices involve more tax forms, payroll work, or legal upkeep. Ask what you may need to pay for each year.

Common costs to discuss include:

• Bookkeeping and tax preparation.

• Payroll services, if needed.

• State reports and filing fees.

• Legal advice and document updates.

For example, an S corporation generally files a separate federal tax return. Its owners also report their shares of business income on their own returns. IRS overview of S corporations

Compare any expected tax savings with the added costs.

Suppose a choice may reduce some taxes but adds payroll and filing fees. The savings may be smaller than they first appear. Ask for a comparison based on your expected profit, not just your sales.

5. What Does the State Require?

Federal tax rules and state filing rules are separate.

For a Texas business, ask about franchise tax and yearly information reports. Even if no franchise tax is due, an LLC or another covered business may still need to file an information report. Texas Comptroller report guidance

Tell your advisers where you will do business. Mention plans to work, hire staff, or open a location in another state. They can check whether more rules apply.

Then confirm who will handle each task.

The person who forms the business may not handle its tax returns or state reports. Ask what each service includes, what it costs, and which tasks remain your responsibility.

6. What Are Your Plans for Growth?

Think about the next few years, even if your plans are still rough.

Would you like to bring in a partner? Seek money from investors? Pass the business to a family member? Sell it one day?

Those goals can affect which choice fits.

For example, S corporations have limits on who can be an owner. They also have rules about ownership shares. Those limits may matter if you plan to seek investors. IRS S corporation rules

You do not need to plan for every possible change. Focus on the ones that seem likely.

Also ask what would happen if you changed the structure later. A change can involve taxes, legal work, and added costs. It helps to know that before you choose.

Getting Ready for the Conversation

Bring a short summary of your business. A page of notes is enough to start.

Include:

• What the business does.

• Who will own it.

• Expected sales and costs.

• How much you need to take home.

• Plans to hire, add owners, or grow.

If the business already exists, bring its setup papers, recent tax returns, and any IRS letters about its tax status.

Ask your tax professional to explain the tax choices and ongoing filing needs. Ask an attorney about legal setup, owner rights, and personal risk.

You should leave with a clearer view of the choices, costs, and next steps. There may be more than one workable option.

To discuss the tax side of entity choice, contact the firm about your business and the services you need.