Many new business owners believe choosing and forming their business entity is something to check off their list on a weekday night after researching on the web for an hour or so.
Please be careful. There are many complexities and issues to consider when choosing the right business entity based on your situation. Here are a few myths that may help you in your quest:
1. An LLC will save me taxes. Wrong. The Limited Liability Company was designed to provide asset protection. They are perfect for holding assets or for partnership relationships between individuals or other corporations. You can actually have an LLC 'taxed' as an S-Corporation or C-Corporation for tax purposes, but in and of themselves you don't need an LLC to take write-offs and they won't save you taxes.
2. A C-corporation will save me more taxes as a small-business owner. Wrong. This strategy is oversold consistently across the country. Promoters will claim that all of the Fortune 500 companies are C-Corporations and provide more deductions, so you should use the C-Corp too. This is far from the truth.
Many of the deductions are extremely unique and don't fit the small-business owner, or could be written-off just as well in an S-Corporation and not have the double tax problem. Run the numbers before falling prey to this sales pitch and you'll be surprised.
3. A Corporation gives me better asset protection than an LLC. Wrong. You might even hear that LLCs provide better protection than Corporations. Myths prevail on both sides of the isle. The truth is that the corporate veil and the protection it provides is a legal concept applied uniformly across the country under statutes and years of case law. Real asset protection with your entity comes down to following corporate procedures, not comingling funds, using the company name on all documentation and acting responsibility in the management of your company.
4. A Nevada or Wyoming Corporation will save me taxes or better protect my assets. Wrong. I have advocated for years that this is one of the greatest scams in the business industry. Bottom line: if you are doing business in your home state, or any state for that matter, they are going to tax you on the profit you make. Second, if you need to register your company in your home state where you are doing business, the courts will apply your state's laws when it comes to asset protection.
Yes, there are some unique instances in which setting up in Nevada or Wyoming could make sense. However, it is grossly oversold to far too many small-business owners.
5. The IRS highly audits S-Corporations for salary allocations. Wrong. Many small-business owners have discovered the benefits of an S-Corporation and saving on Self Employment taxes. Don't be concerned that this strategy is disappearing any time soon or that the IRS is hyper focused on these business owners. True, you need to carefully consider your payroll allocation each year and make sure it's reasonable, but millions of other S-Corporation owners are doing the same thing and you're in good company.
6. A Sole-Proprietorship is always a bad entity. Wrong. Oftentimes a brand new business owner can and should utilize the Sole-Proprietorship until their business appears viable and starts to grow. Don't get oversold on an entity before you start your business unless it's a larger project and partners or financing is in the mix.
7. Online company formation services will save me time and money. Wrong. For some reason, entrepreneurs have come to believe that using an online company formation service is an acceptable option even when they are getting started with their first business venture. This couldn't be further from the truth. Choosing the right entity can save you thousands of dollars in taxes, administration costs and wasted time, however it has to be chosen carefully. Don't step over the dollar to pick up a nickel.
These are just a few of the major issues that need to be considered when setting up your business. Paying a few extra hundred dollars to get a consultation from a lawyer or CPA can be a valuable investment when choosing the proper entity.
The author is an Entrepreneur contributor. The opinions expressed are those of the writer.
Mark J. Kohler, a certified public accountant in Irvine, Calif., is a partner in the accounting firm Kohler & Eyre, and the law firm Kyler, Kohler, Ostermiller, & Sorensen LLP, specializing in business, estate and tax. He is the author of What Your CPA Isn't Telling You from Entrepreneur Press.