I’m thinking of incorporating. What kind of corporation are you?
I am going to give you a super valuable and totally awesome advice: talk to an accountant. I am not qualified to advise you on the type of corporation that’s best for you.
Here is some background information for information purposes only. No matter what you choose, if you are earning over 100K per year, I strongly recommend that you get an accountant and a bookkeeper. For example, we pay ourselves through Gusto, a payroll service, and our accountant is authorized to adjust our paycheck breakdown. We also record everything in Quickbooks and our bookkeeper has access to that. She tracks the business expenses, queries as she goes along, and that helps us avoid the nightmare of trying to sort through everything ourselves in a panicked rush at tax time.
As a small business owner, you have a few choices when it comes to incorporating.
Sole proprietor is the owner of the business and is responsible for all of the business’ debts. Sole proprietor pays their personal income taxes, meaning from the IRS’ point of view, there is no difference between you and the business. You do not have to file a business tax return, but you do have to pay a self employment tax which is 15.3%, I think. A lawsuit against your business will name you as the defendant. Your business’ creditors are your creditors. If you die, your business dies with you.
S corp is corporation that shields you from legal liability and helps you lower your taxes. In a lawsuit, your business is sued rather than you. You can bequeath it to your children or spouse. You must be a US citizen to own one.
S corp is also a pass-through entity protected from double taxation. What does this mean? It means that it’s a business that’s not taxed by the IRS. You still have to file tax return, but all profits and losses are passed on to the owners, who are viewed as shareholders. Ilona Andrews, Inc. is an S corp so I can tell you a bit more.
Each year we start with theoretical zero money in our business account. As the business earns money, it’s deposited into the business account. We use a payroll service to pay ourselves and our children a salary. Then at the end of the year whatever profits are left in the business account are given to the shareholders as distributions.
So let’s say we start with $50,000 in the business account and we have two shareholders/owners, who each draw $3,000 per month salary. The business and employees pay taxes out of their paychecks and pay into Social Security and so on. Over the course of the year, the business earns additional $100,000. Our business owners earned $3,000 x 2 x 12 = $72,000. That leaves us with $78,000. Let’s say we hired some contractors to make book covers and edit to the tune of $8,000. We now have $70,000 left over. At the end of the year that money is split in 2 and counted as additional income, so each of the owners gets $35,000 extra and has to pay taxes on it. Here is a more complicated but likely much more accurate breakdown of it.
But, and this is a big but, when you get those dividends at the end of the year, you do not have to pay Social Security or Medicare taxes on that income. So you can save quite a bit. How much depends on your state. California, for example, will charge you an $800 annual fee for the privilege of operating an S corp. And you do still have unemployment insurance.
If you are choosing to incorporate as an S corp, it is essential that you draw a reasonable salary and adjust your tax rate, so a) you are not hit with a big bill at the end of the year and b) IRS will not come after you for tax evasion. This is where an account helps you. I can tell you that 2/3 of our monthly paychecks goes into taxes. We choose to pay a lot of taxes monthly, and our accountant constantly adjusts it. We are not rich enough to avoid taxes. 😉
To reiterate, you have to draw a reasonable salary. If you pay yourself $10 per month and then take $100,000 distribution at the end, that ain’t gonna fly.
LLC is a limited liability corporation. The main advantage here is the legal protection from a lawsuit. It’s this kind of mutated business entity that is a corporation but can be ran and taxed as a sole proprietorship. S corp requires incorporation, and Gordon and I are officers of the company. He is President For Life. That’s his official title. Don’t ask. LLC can be ran without officers or board of directors.
You don’t have to be a US citizen to own an LLC. It is also a pass-through entity, where the business gains and losses are the responsibility of the individual owners. You are going to get hit with self employment taxes, but you don’t have to draw a salary. LLC can’t issue stock, while S corp can, but it’s only one type of stock.
Anyway, LLC is confusing. Get an accountant.
C corp is a “default” corporation according to IRS. C corp pays taxes on their income, and then its employees pay taxes on their individual income. You get taxed twice compared to S corp but there is no restriction on ownership. In S corp you can write off business losses on your personal tax return, although there are restrictions on how many times you can do this before IRS will come knocking on your door. In C corp, you can’t. You are completely separate from the business.
If you want to grow and get funding, C corp is the way to go. If your business is going to have a limited number of employees, S corp might be better. You can issue all sorts of stock as a C corp. You face less scrutiny from the IRS.
You know what I am going to say, right? Talk to an accountant. Strange women on weird blogs giving business advice is no basis for a system of incorporation. You can’t expect to obtain taxation breaks and legal benefits just because some
watery tart writer person threw a business summary at you.
I mean what have taxes ever done for us? Besides public schools, fire departments, roads, trash pickup, the US Post Office… Ok but aside from education, sanitation, public order and roads, what have taxes ever done for us?
Thank you for this. I am astounded at the number of people who say, “Freedom isn’t free!” to show how much they love the military – which is what a massive chunk of our taxes goes to support – and then turn around and object to paying taxes. ANY taxes. That’s right, freedom ISN’T free. Keep it in mind next time you’re whining about taxes. Look all around the world; you’ll never find a better bargain.
Hehe, Monty Python is a classic 🙂
Kim Stewart says
Taxes are the dues we pay to live in a decent society.
Patricia Jenkins says
Sorry Gordon, but the US Postal service gets ZERO money from the federal government/your taxes. I’m a retired Postal Service Supervisor, so this I know.
I hate to argue with an expert, but USPS is not allocated tax money in the regular budget. It still receives tax payer money in the form of loans, since it hasn’t operated at a profit since 2007. 🙂 “In the CARES Act, Congress provided a $10 billion emergency loan to the USPS.” <--- Tax revenue.
Donna A says
I can’t believe I’m going to help the pro taxation argument, but . . . the UK’s Royal Mail postage system is government funded as are many other countries postal services and not just as in government funded via bail out loans.
I can assure you most sadly that US citizens are not the only taxpayers in the world, taxation is supposed to go towards community services after all (Even if that allocation can sometimes be a whole other highly debatable issue ????)
William B says
The USPS receives federal loans to prepay health benefits for retirees which were mandated by congress. This is something no other federal or private entity is required to do. So while there is a line item that says loan, no money goes for the day to day operation of the USPS.
Patricia Jenkins says
I believe that was around the time th3y ordered the USPS to refund retiree health benefits for the next 50(?)years, something no one else has to do.
Most interesting! Thanks for the non-legalese, too.
And I have the tax “discussion” with various friends all the damn time. They want the benefits of our govt without having to pay for it. Drives me insane.
Kansas learned this ALL TOO WELL just over 10 years ago, when Brownback & a aggressively right-wing no-taxes-ever legislature voted in a tax bill that gave LLCs a free ride, but still taxed wages. LLC owners promptly stopped paying themselves wages (not that many did in the first place; they usually just drew money out as needed, and declared it all “distributions” at the end of the year). Our tax revenues dropped disastrously, and the state was nearly bankrupted. Only some very fast, very loose money transferring (sell billions in bonds through the one fund allowed to have long term debt, the highway fund, then sweep all that cash into the general fund, then change the highway repair regulations from once every 12 years, to once every FIFTY years) kept us afloat.
And now that the voters have put in a supermajority of right-wing legislators AGAIN, we are going to be right back in the same boat….
Why did you start this? Please don’t start this.
Mary Beth says
Back in the stone age of my youth, I tried to go the self employed route. Clueless is a kind descriptor.
It all went down in flames, but I did manage to avoid bankruptcy and bad credit.
Live and learn.
“watery tart” ????
That’s really interesting actually. Thanks for sharing. I learn lots of random stuff from you guys.
Where do people post questions to ask you or emails? I thought you did away with your contact email?
They ignore the rule or stalk me on Facebook. 🙂 No escape.
Oh. Haha. Well thanks for being a good sport and answering questions anyway.
+1 I do learn a lot here.
+1 I learn a lot here too! So interesting!
Thank you thank you thank you for the brilliant Monty Python reference. The rest of the advice was excellent, too.
Brilliant post!! Especially the last paragraph!! That made me laugh out loud!
Yes, hire an accountant. That’s what they go to school for. Also, a lawyer. Trying to navigate business law and finances by yourself is a dark and scary path.
Your business-of-writing columns are always eye opening and an education!! Thank you for writing them.
I absolutely agree, talk to an accountant. The whole system is so convoluted that you end up getting yourself into trouble when you try to google your way through it.
I never really paid attention to different ways to incorporate, was surprised at how different they are. I can certainly see why you would want to talk to an accountant.
It is interesting to think that before certain software and apps came out that you had to do all the financial parts by hand. We use quicken for our home use and I am glad it makes balancing the checking account easy.
Diane Wilson says
Yes, talk to an accountant! My B.A. is in General Management, with a minor in acounting (18 hours, all but tax), including finance, marketing, business law, labor, operations, 12 hours economics, and more. There is NO WAY I would try to do this myself, for liability reasons if nothing else.
“ Strange women“? Where is Ilona and what have you done with her?
Moderator R says
It’s a Monthy Python reference hehe ????, as is “watery tart”.
“Strange women lying in ponds distributing swords is no basis for a system of government”
Hope this helps ☺️
Thanks for the breakdown of definitions between the types. I prefer this much better to advice or specific legal definitions. Much easier to digest so I might sound like I know what I’m talking about if I find myself needing that accountant meeting.
Donna A says
And don’t forget to take a shrubbery along for payment!
Those accountants cost an arm and a leg (tis but a scratch ????)
I know nothing of corporate finance, but love a bit of dead parrots and funny walks. Some say Life of Brian is best but I’m a Holy Grail girl 100%. One of the best things I did was set my youngest brother on to Monty Python and aged 12 he started a clan in an mmorpg called The Killer Rabbit of Caerbannog #ProudSister
Linda Trainor says
Hahaha ???????????? I enjoyed reading this and as I’m in another country it’s just knowledge ☺️☺️☺️☺️
So just out of curiosity… Are you buying your health insurance from ACA as a private couple or is the business buying it on behalf of its employees? Can businesses even get plans on ACA for employees?
Y Kagan says
After trying an S Corp for several years in California. I changed accountants and we have been a general partnership + liability and umbrella insurance for 13 years now. Better for my circumstances in California. This is complicated. I fully agree with your advice: Find a good trustworthy accountant. Talk with him.
Them. Women are allowed to be accountants now.
thank you! Great advice on how to start a conversation with an accountant!
Thank you, Ilona and Gordon! You’re always so open with us.
Come and see the violence inherent in the system! Help, help, I’m being repressed!
Donna A says
Which anarcho-syndicalist commune are you from? You should report it to your executive officer ????
Valerie in CA says
Correct in the comment about CA charging the annual fee of $800.00. If memory serves, it’s federally tax deductible. But you are going to have to dish out the $800 and get it back on your federal tax return. So you are correct, people should talk to an accountant.
I’ve been gathering information for a friend stating a business. Good information here. When I told him why he should not be individual sole proprietor he nearly had a heart attack. IMO his liability is too great for the type of business he wants to start. As immigrants from South America he and his wife have worked very hard for all they have. I’d hate for some ahole to sue the business and they lose everything in lawyers
fees. Good post
If only the IRS explained their stuff that simply!
Patricia Schlorke says
If the federal government can make things convoluted, they will. The state government isn’t any better. ????♀️
SnowCat MacDobhran says
There are no words to describe how much we love our account. Talk to your accountant, they are paid to know this crap so you don’t have to. It’s so nice to not be hiccupping stomach acid on every estimated tax day. Hubs is self employed, I do the books. I hate QuickBooks with the heat of a thousand suns, if his business gets bigger, I’m going to have to use it. (Right now its killing a fly with a shotgun.)
C Lee says
I have read about the differences of each when I went through a 10 wk entrepreneurial program and yet your explanation totally makes more sense. I don’t know if it is the fact that I can ‘hear’ you saying it, the examples, or that my eyes didn’t automatically glaze over. Thank you, always, for your blog and sharing thoughts. Your kindness and wit are a blessing to those who get to enjoy it. Namely….me!
Bill from nj says
Having taken accounting as part of a management degree, and having to wade through even personal taxes, I agree totally,talk to a tax accountant, it will spare you a lot of grief,same thing with a lawyer if you incorporate.
As far as paying taxes,I see the people complaining about taxes, how they get nothing for what they pay. The irony is many of them live in places that get more than they pay in. But I even.have more fun,I list the things the government paid for that lets them complain online, the electronic computer, the transistor, the integrated circuit and vlsi, fiber optics, the internet and internet tech like packet routing, routers and the ip protocol were all developed on Uncle Sams dime, as was packet radio ( wifi), the basic tech behind lcd and led tech.
They just love it when I quote some stuffed shirt from IBM,’ who the hell wants to network computers? No one wants that!’
Ann Christensen says
But what if the watery tart hands you a sword? Can you then issue stock certificates to your children so they can receive dividends to help pay for their education? Can you wear a crown while doing so?
I never know what esoteric knowledge I will pick up from your writing – here or in the books you write.
Being the ultimate in self-employment, ie retired, this is interesting but, alas, not useful to me. It is, however, as fascinating as always.
Thanks so much for sharing. My first novel project is coming out in July. It was a labor of love undertaken at the relentless request of my family, to revise a massive manuscript my uncle wrote back in the 60s. I undertook the revision effort to get the manuscript down from 150,000 to 97,000 words and was offered a publishing agreement by Touchpoint Press last fall. Historical southern literature.
I listed my writing activities as a sole proprietorship for tax purposes and began working on a sequel. If the sequel also sells, I may need to rethink and consider going to an S Corporation. Luckily, my son just graduated with a master’s degree in Accounting. Heh. At least I have a place to start asking questions!
These business posts are fascinating. Thank you for the info.
Help help I’m being repressed!
I have a degree in Finance, and have lived in Florida, California and Texas. In my experience most sole proprietorships would be better organized as an S Corp, they would be less liable legally and pay less taxes.
But specifics matter, definitely discuss your circumstances with a professional in your area.
Love this. Being an accountant and working for a totally awesome firm, I whole heartedly agree with the message.
Talk to someone that is knowledge and receives annual training to keep up with the ever changing rules! You can get Gusto and QuickBooks on your own. However the accountants are also going to help you with all those nasty “which state do I owe taxes in now” questions as well. They can get the attorney to help and then do the rest for you!
Such randomness on this blog but you have such a way with any writing that it keeps me reading.
I am anxiously awaiting the next Baylor adventure!
Ray Van Houtte says
I’ve done most of these (not LLC). I found myself doing a C Corp when I expected to have to handle some complex Intellectual Property issues with joint ownership agreements. YES on accountants, bookkeepers and lawyers. Kept me out of trouble.
Really interesting reading thank you!
Although I hope I wasn’t the only one who went looking to see if there were a, b, d etc. Corps as well!
Stacey Kuyf says
Great post. Just to let you know, I’m also an Scorp as a green card holder/ permanent resident.
I love these mini-financial seminars. Very cool.
RJ Blain says
Correction in California:
$800 is only if you earn very little. If you earn more you pay more. If I had an LLC or S Corp right now, my yearly bill would be over $5,000 a year just to have it.
It scales by how much you earn. $800 is just the lowest tier.
Hiya – one quick note – I am a legal permanent resident of the US (Cdn citizen w green card) and was able to own an S-Corp.
Also would advise anyone out there who is interested in incorporating to make sure your business will earn a certain base amount to make the additional costs (and pain) of payroll etc worthwhile. A lawyer here in WA state told me back in 2016 the break even point was around 75K. Unsure if that’s true but an scorp is a lot of work and expensive if suddenly you have a baby and are working very part time (guilty).
I’ve heard that too. If your business earns 75 cents a year, you don’t have much to worry about.
Oh! Just ROLLING around in my chair laughing! Very good summation. Being married to an accountant who knows all that stuff means I followed every word, and your advice is very good. Get an accountant. But get an attorney, too. Get the filing correctly done. If you don’t know what you’re doing, ask ask ask questions until you know what you’re doing and why you’re doing it that way. Until you understand it all, don’t jump into it.
Lynn Thompson says
Thank you, Ilona Andrews for the sage advice.
I ROFLOL over Gordon’s title. President for life. That has so many different possibilities.
Of course I am not one to talk. Titan is head of security and Amazon seems to have a big training issue for delivery drivers. You Never turn your back and run from a big dog such as Titan. Dogs of any size are prey driven and faster than a human unless human teleports.
Thanks for education on types of corporations. I totally agree accountant and additionally lawyer as different states in USA have different zoning / tax laws even if you are an online only business. Then there are the multiple inspection / licensing agencies depending on what company does.
I would agree with what you said, but would add that if a business is complicated, you should think about using an attorney – at least for the initial setup. Every state is different, so what works in one state may not work in another.
Trish Henry says
Wow! Very interesting! And entertaining. ????????
You may think this is extremely odd, but thank you. I just started a business last year for the very first time and became REALLY confused by everything. I sort of figured it out, but could not really explain the different categories as well as you. This is helpful.
Cheryl M says
I would also recommend talking with a lawyer that deals with sort of thing. Often times they not only have a law degree, but also in the applicable areas of finance. They can better explain the legal reasons as to why one sort of corporation over another, especially as it relates to your state of residence.
Bill b says
I think LLC is actually limited liability company, not corporation. Has the advantages you described. It’s what I chose for my business. There are a couple of bear traps.
Bwahaha! Thanks for the Holy Grail reference!
Help! Help! I’m being oppressed! Now we see the violence inherent in the system!
I think this is one of the best, short explainations on this subject I’ve ever read after two semesters of Business Law.
As a professional tax preparer, I have SO many times run across a client who listened to his golfing buddy/barber/neighbor about incorporating their business, and had to straighten out the resulting mess. Very good summation of the different types of business forms. I mostly tell people not to even think of incorporating until they are consistently CLEARING $35-40,000 a year as profits, so the $75,000 gross break-even point sounds along the same lines.
I am glad you all are doing so well as professional writers!
Melissa B says
You guys made my day with this post as I do a lot of accounting and tax work and I love what you said with the S Corp owners needing to pay themselves a “reasonable salary”. Loved your summary. Cheers!
Wow, I learn the most interesting factoids on here. Things I never would’ve thought to look into pop up and provide wonderful summaries on the subjects! As a lover/collector of random info, it’s so much fun getting on here and seeing a new topic summarized in simple enough terms for someone who knows nothing about it to read 😀
And I love you’re reiteration of “get an accountant,” lol.
Susan B says
I have made my living as a tax accountant since the mid ’80s and I couldn’t have summarized the different forms of business organizations any better than you did. Excellent advice, especially “Talk to an accountant”. Find one by recommendation if at all possible; I have picked up prior year returns for a new client that made me wonder how the person who prepared the return ever passed the CPA exam.
*Me an auditor with a masters in business law degree* FINALLY, something I’m good at!!!
(2 seconds later)
Note to self: you studied in a different jurisdiction you idiot! THANK YOU for the information.
Goodness. You do receive an interesting range of questions, don’t you? I enjoyed reading your answer, thank you.
Elizabeth Shields says
Great summation. I would only add for anyone who has made it this far into the comments, that self-employment tax is, essentially, your Social Security and Medicare tax. Since those owners aren’t drawing a salary, you have to pay both employer and employee portion. The employee portion is tax deductible in a different section of the return.
And sometimes (often here in Kansas) an LLC can also be an S-Corp. Even more confusion!
Seconding the best advice: get an accountant. They are worth their weight in gold.
And please talk to a lawyer in addition to your accountant. They are both experts at different things and shouldn’t be depended on to know the other field.
Each state has slightly different rules around the different entity types which can make a big difference to how you legally operate, and that is different from how the IRS looks at you for federal taxes, or even state taxes. For example, in Wisconsin, while an LLC can be taxed as a pass-through entity, it doesn’t have to be (you can be an LLC which has elected S-Corp status), and even though the IRS may consider a single-member LLC the same as a sole proprietorship for tax purposes, to keep your legal protection, you still have to keep your funds seperate, including things like the LLC paying the sole member rent if he/she is working out of their home. Sorry…small business paralegal over here 🙂
Pamela S says
Off topic comment here… I am currently reading ‘Blood Heir’. I love it! My question is do authors like to receive happy comments from readers about their books? I would assume that, yeah, who wouldn’t? How do you like to receive these comments? Twitter? On your blog? Is there a preferred way (Obvs – buy the book)? Thank you.
Moderator R says
The IA Twitter account is mainly a blog feed.
Comments on the blog are always read ☺️. And ofc it’s very useful to get reviews on the appropriate sites!
So thrilled you love Blood Heir!
This information is interesting and helpful, thank you for posting.
this blog is proof i will read anything you write. i too own a small business and try to forget everything i know about corp structure (that is why i pay an accountant and a book keeper) and yet i read this.
“Strange women on weird blogs giving business advice is no basis for a system of incorporation.”
This may be true, but I worked for an attorney and accountant for years and never got as comprehensible an explanation of S corps as you gave here (I had to deal with a handful of LLCs and C Corps, so while I’m not sure I ever got a very good explanation of them, I organically absorbed a certain amount of comprehension of what they require locally.
I also never got a very good explanation of tax brackets; when I got a raise at my new job and thought I might be going up a bracket (I fell just below the cut-off, it turns out) I ended up going back to my old office and borrowing the giant book of tax regulations to give myself a crash course in how taxes are calculated.
Thank you for this type of post, where you tackle knowledge gaps like this. Yes, people should go to an accountant for details on how it applies to them, but this kind of post can throw up a flag of “hey, you might now or in the future be in a situation where going to an accountant about this may be advantageous!” and I appreciate that.
Michelle Botwinick says
I’m a Certified Public Accountant and have this same discussion several times a week. You explained it very clearly! You are a model client and I hope your Accountant appreciates you.
After reading the next blog post I immediately thought of this post. I would settle for tax code that followed a 10 finger rule. I would throw a party if it followed the 5 finger rule.