The Best Business Structure for the Phases of Your Business
Introduction
There are two main reasons to have a business structure:
(1)Asset protection, and
(2)Tax reduction.
In this Home Study Course, we’re going to look at various structures that you can use for businesses. You may have heard that using an international structure is the best for privacy and you never have to pay taxes. Or, you might have heard that you should always use a trust. Or you should always have an LLC, a secret type of corporation or who knows what all. There are a lot of opinions floating around about business structures.
There are legitimate business structure options. And there are some that aren’t so legitimate, at least not if you use them the wrong way. The trick isn’t to find the one solution for everything, but rather to find the right business structure for you and your particular set of circumstances.
Once you’ve established the right strategy, you (or better yet, your advisors) need to properly implement the strategy and then report it to the IRS and state agencies via tax returns and state filings.
It all starts with a strategy developed with someone you trust to both know what they’re talking about and to have your best interests at heart.
Find Someone to Trust
How do you find someone you can trust? There are three things I suggest you check out first.
- What is the education & experience of your proposed advisor?
If he is new to the industry (less than 5 years), make sure you’re not getting someone who is long on theory and short on practice. I don’t recommend you ever hire the one person who can do it all, because that guarantees you’re going to get someone who can do a little of a number ofthings but probably isn’t an expert at any of them.
I don’t believe that everyone needs a college degree and accreditation to succeed in business. But I do believe you need a real actual expert when it comes to legal and tax matters. If nothing else, you need an expert with a license if it comes down to talking to the IRS or state offices.
Most high-level experts aren’t going to cough up their client list or even give you a client referral because confidentiality is important to clients. Since you can’t talk to a client, how can you find out if the expert really is an expert? Check his or her credentials. If she’s a CPA, then you can contact the State Board of Accounting and make sure she really is licensed and if there have been any complaints. Almost all CPAs will receive a complaint from time to time, so the important thing is to find out what the disposition of the complaintwas and if the complaint was even legitimate.
If you’re planning to hire an attorney, you can check with the State Bar to see if he is licensed and if he’s had complaints.
If the expert you want to work with is not licensed, make sure you have other experts you trust putting their reputation on the line to refer him. For example, if you want a foreign corporation or trust, I have a referral. But he’s not licensed in the US. You need to trust that I’m reliable and that I care about making a solid referral for you. So, in a way, you’re relying on your trust of me to know what I’m talking about and to have your best interests at heart. And based on that, you can be confident to work with the any referral I give you.
Just as a side note, I turn away at least 90%of the people who want to pitch some product or service to my list. They offer me money and then when I say, “no”, they offer me more money. They don’t get it at all. I am putting my integrity on the line when I make a referral. You can’t put a price tag on that.
- Does your prospective advisor have more questions for you than you have for her?
As much as you may wish it really were so simple that one business structure was everything you ever need, it isn’t that simple because wishing doesn’t make it true.
Your advisor needs to understand where you are now and where you are going. She will ask you questions. In fact, she’ll probably ask you a lot of questions. If she doesn’t and just makes a recommendation without really knowing anything about you, she’s either trying to sell you something, doesn’t really understand the process or doesn’t care about your result.
There is no ‘one size fits all’ in business structures.
- What is the POV (point of view) of your proposed advisor?
I had a client once tell me the story of why he left his long-time CPA. He liked his CPA and had fun visiting him. He thought he was doing a good job for him. And since he trusted him, he had the CPA review each possible real estate investment. One after another, the CPA said, “No” and so his client didn’t purchase the property. Finally, he asked his CPA, “What type of real estate would you invest in?”
The CPA replied, aghast, “None! I don’t like any kind of real estate investment. I don’t even own my own home.”
And that’s when he decided he had to find another advisor if he wanted to be a real estate investor.
Your advisor’s POV is going to color decisions. If he has experience working with people who have successfully done what you want to do, then he’s going to be able to share what works and what doesn’t. If he has seen huge success, he knows it’s possible not just for his other clients, but for you, too. And you’re not going to have to pay to educate your advisor or spend your time convincing him.
Some questions to ask the potential advisor to determine your advisor’s POV:
Do you personally (whatever it is you want to do…invest in real estate, have an online business, etc.) …?
What is the average income/wealth of your clients?
How much does your most successful client make doing (whatever it is you want to do)?
The money you pay a good advisor is an investment. The fee you pay someone to prepare your tax return is an expense.
As soon as you make that distinction, you’ll realize the question isn’t who is cheapest, but rather who will give you the best return on your investment of time and money.
Before You Put Your Business Structure in Place
In just a bit, we’re going to go through the questions you need to answer first before you can determine the right business structure for your circumstances.
There are a couple more things to consider before you put that plan in place.
(1)Do you have a truly customized solution?
It bears repeating. Don’t go with someone who says the answer is “always” yada yada yada. It could be someone who says you also should use a trust. Or always use a corporation. Or always use an LLC. There is no one answer that is always the best answer. Most situations are different. Make sure the advice you receive is the best advice for you!
(2)How flexible is the structure?
If you’re just starting out, the only thing that’s guaranteed is that something will change. Is your structure flexible? And equally important, how will you know when it’s time to make a change?
(3)Who will implement your strategy?
Sadly, too many people get fired up about having a business structure and then try to save some money and do it themselves. They get lost somewhere along the way and never do all the required steps and required steps. If the set up is only partially completed it’s the same as never having had a business structure in the first place especially when it comes to asset protection. In other words, you’re at risk with no protection.
(4)Do you know the corporate formalities to follow?
Ask your corporate formation specialist on the formalities you need to follow. This includes notice (how you sign contracts and what you put on marketing pieces), meetings (evidenced by minutes), no commingling, annual state filings and other procedures. You must observe the formalities if you want to keep the structure intact. Otherwise, your asset protection is out the window.
A business strategy has three stages: strategy development, implementation and reporting/compliance. If you miss one of these steps, you will not have the good results.
Questions You Need to Answer About Your Business
Before you can know what the best business structure will be, your advisor needs to know a few things about you. Here are some questions to be prepared to answer:
(1)What kind of business or investments will this be?
If you have a business selling products, you have more options when it comes to business structures. If you have a professional service, you probably can’t be a C Corporation without facing the PSC (personal service corporation) excess tax issues. If you have appreciating assets, you don’t want to hold them in a C Corporation.
Generally speaking, you want to use a corporation (S Corp or C Corp) for a business and an LLC (single member except in Colorado or Florida) for appreciating property like real estate.
A trust is generally used for estate planning purposes. You might set up a corporation or LLC and have the interest held by a trust.
You can use a foreign entity if you meet some very specific rules regarding where your customers are and where your fulfillment is and if you don’t bring cash back to the US. Otherwise, you might get some good asset protection in exchange for high legal costs, set up costs and maintenance costs. And, as a US citizen, you still need to report what you’ve done.
Where will the nexus be for your business?
It’s not enough to know the type of business structure you need; you also need to know where to form the entity. Nexus means connection. What country and/or state do you have a connection with?
If you live in California, California (CA) has made it easy for you. They’ve decided that if you have a business, no matter where it is, it will have CA nexus. Since CA has a minimum fee of $800 per business structure, just figure you’re going to have to cough up that money too. So for example, if you live in California and are a partner in a business that is located in Arizona, that businesswill have (at a minimum) California and Arizona nexus.
There are two forms of state nexus: sales tax nexus and state income tax nexus. If you have sales tax nexus, you are required to collect and pay sales tax for sales made to customers in that state. If you have income tax nexus, you are required to file a state income tax form and pay tax on attributed income for that state. If you think you might have an issue, talk to an expert before you get your business going. Otherwise, you could have a state chasing you for a lot of taxes and penalties.
If you have foreign customers, foreign fulfillment and don’t need to bring the money back into the US, you may not even need to have a domestic entity. Maybe you can legally pay no state or federal tax with a foreign entity. Setting that up properly can be a little trickier, so you’ll need to make sure you have an expert who understands the rules.
(2)Where do the owners of the business live?
In most cases, if you’re an owner of a business, it will mean that you have your nexus in that state.
A client of mine lived in New Jersey and commuted to a W-2 job in New York City. He was a computer guy. In his spare time, he discovered a nice little niche in Florida. He put up websites, set up a call center and started making online sales in Florida.
When the income became significant, he paid for a consultation with me. He had some very specific questions about nexus. Where should his company be located? Where does have to pay tax? Florida? New York? New Jersey? All three?
The work clearly was done in Florida. The customers were in Florida and the fulfillment of the services was in Florida. So, he needed a Florida entity. Florida doesn’t have a state income tax, so at first pass, it might seem like he’s getting away with no tax.
He lives in New Jersey and had, until recently, worked in New York. He did the entire computer programming from NJ.
Since he lived in and worked on the business in New Jersey (NJ), he also had NJ nexus for the business. If he didn’t do any work in NJ, he still would have pay NJ income tax if the Florida (FL) business were a flow-through entity like an S Corporation. Since he worked on the business in NJ, he may have to additionally register his company in NJ. In his case, he did not. But it’s a question you may need to explore for your own situation if you’re working online for your business that is located in another state.
He also wondered if he would have to pay New York (NY) tax on the income he earned from the business. The answer to this was “no.” He had NY tax on the NY income he earned while he lived in NJ, but that was because he actually worked in NY. In this case, the nexus for the business is just between NJ and FL. There will be no NY tax.
Nexus is complicated. In most cases, you just need to break it down – where is the work done? Where do the sales happen? And in the case of California, do you have any kind of link whatsoever with the state? If so, your income maybe treated asCA income and you will have CA tax too.
(3)How much income do you and the other owners have outside this business?
If you have high income before you count business income, you may want to consider using a C Corporation. The C Corp is the only entity that reports and pays tax itself. The other business structures flow the income through to the owner’s tax returns.
On the other hand, many businesses have tax losses for the first few years. If you use a C Corporation, the loss would not flow through to you personally and instead would besuspended inside the corporation until a future date when it can beused to offset income from the corporation.
And finally on the third hand, the S Corporation is flexible. It’s relatively easy to go from an S Corporation to a C Corporation if you decide that is a better structure. It’s harder to go from a C Corporation to an S Corporation without some undesirable tax consequences.
(4)What structure do you have now?
Before we decide the best structure for you with your new venture we need to look at what type of business structures you have now.
If you already have businesses with full time employees, you will be limited in the kinds of benefit programs you can set up in your new business. This is an important consideration if you’re thinking about a C Corporation because you know owner/shareholders get the best tax-free benefits with that structure. If you have other businesses with similar ownership and control, you wouldneed to include the employees in those benefit plans as well.
You can only have one C Corporation. If you have more than one with the same ownership, they have to collapse together for a consolidated return. If that’s the case of you, you won’t want to have a C Corporation.
(5)How will you fund the business?
If you plan to bring in equity partners, you need to consider what you’re going to offer them. Most of the time, businesses that look for public financing are C Corporations. If you raising money for a real estate venture, that’s often done through a Limited Partnership with a business you control holding the general partners spot and your investors taking limited partner positions.
(6)What is your exit strategy for the business?
What is the end game for your business? If your plan is to sell, you need to consider what kind of sale it will be (asset sale or stock sale), who would be the purchaser (big company, someone buying a job, etc.) and whether you want some of your employees to participate in the purchase. The bigger the sales price, the more likely you’ll want to be a C Corporation. That’s especially true if plan some kind of stock swap, merger or equity sale.
Let’s Recap
If you’ve gotten the idea that there are a lot of things to consider when it comes to selecting the right business structure for your business, you’re right.
So far, we’ve discussed:
(1)Find the right advisor.
Make sure the person you hire to advise you has the experience and credentials that demonstrate he or she has the knowledge. Plus, you need to make sure the advisor has the right POV.
(2)Answer some basic questions about your business.
There is no one right business structure. Your business is different than anyone else’s business. And those differences are important to note. The 7 questions you need to be prepared to answer deal with: