There are a couple of steps that you will undergo when setting up a business. One of which is choosing the correct business structure for you. This step is critical to the success of your organization as the structure you will affect many aspects of your company. These aspects include how you operate and how the government will treat you and your company.

The Internal Revenue Service recognizes various structures such as sole proprietorship, partnership, corporation, S corporation, and Limited Liability Company (LLC). Each of these structures has its advantages and disadvantages. For example, this article by Walter D. Schwidetzky describes the benefits and downsides of an LLC.

The pros and cons of LLCs

The use of the limited liability company (LLC) has mushroomed in popularity over the past two decades. IRS statistics show a 66% increase in domestic LLCs between 2005 and 2014, and in 2004 LLCs were already popular entities. The core reasons for their attractiveness for a wide range of business purposes are well-known: chiefly, passthrough tax treatment while offering their owners limited liability similar to that of a corporation. 

CPAs may be less familiar, however, with some of the other nontax features of LLCs and instances in which forming one may not be advisable. What follows is an overview of some of these features that help explain the ascendancy of LLCs but also their limitations, as well as some innovative uses of the form that are still developing. Click here to read more…

As we can see, being an LLC can have plenty of benefits for your business, particularly with taxes. This benefit, however, means that LLCs are under heavier scrutiny from the IRS. This article by Troy Lewis and Ron Worsham shows a case where the IRS can sometimes place LLCs under the microscope.

IRS pursuing self-employment taxes from LLC members

Ambiguity in the tax law often provides opportunities for taxpayers. For nearly three decades, how earnings of a limited liability company (LLC) are reported for self-employment tax purposes has been unsettled. (LLC in this article also refers to limited liability partnerships (LLPs) and professional limited liability companies (PLLCs).) This uncertainty has created a divergence in practice that has gone relatively unchecked until recently when the IRS started using legal action to clarify the application of self-employment tax laws to LLCs.

Sec. 1402(a)(13) provides that a guaranteed payment, under Sec. 707(c), to an LLC member for services rendered is subject to self-employment tax. A significant number of taxpayers have claimed that none of the residual profits after deducting guaranteed payments, or so-called distributive earnings, are subject to self-employment tax even if those earnings were allocated to a managing or otherwise actively working member. Click here to read more…

Nevertheless, if you’re worried about signing up under the wrong business structure, there are ways you can remedy this problem. One obvious solution would be to transfer from one structure to another. For example, if an S Corp is no longer enough for your business, you can convert to a C corporation.

One drawback of this move, however, is some complex adjustments that you would need to do on your books. These adjustments can be read in this article by Julia Woislaw on the Journal of Accountancy last September 27, 2019.

AICPA seeks guidance on adjustments for conversions from S corp. to C corp.

The law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, provided for a reduction in the income tax rate imposed on C corporations under Sec. 11(b). Given the significance of the reduction, Congress anticipated that some S corporations might revoke their S elections and convert to C corporation status to benefit from the reduced 21% corporate tax rate.

In many instances, an S corporation on the cash method of accounting that converts to a C corporation is required to change its overall method of accounting to an accrual method of accounting. In that case, Sec. 481(d) as amended by the TCJA requires an eligible terminated S corporation to take any resulting Sec. 481(a) adjustment into account over six tax years (instead of four) for positive adjustments or in one year (in the case of negative adjustments). Click here to read more…

As you can see, the structure of your business will be the road map to its success or failure. Understanding each carefully will safeguard you against choosing one that would give you problems in the long run. You can also hire solutions providers like AldarisCPA. Here at AldarisCPA, we offer top-notch business consulting and corporate entity structure planning. Learn more by setting an appointment with us.