Latest / Second Act Business Owner / Demystifying Business Structures and Entities for Entrepreneurs
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- Ep08 === Choosing Your Entity --- [00:00:00] Lee Gray: Do you know you're listening to my eighth podcast of the Second Act Business Owner? Thank you for being here today with us. We're talking about something that I get lots and lots of questions about, and you'll be asking yourself questions about this when you start your second act. If you decide your second act is in a business, and that is what structure should my business be formed? And, and I'm going to go over a [00:01:00] handful of the most typical types of business structures that most businesses that are starting up. So most of us on this call, people in their second act are considering. So if you're exploring your second act and thinking about starting a business sooner or later I always hear this question, what entity should I form? Keep It Simple --- Lee Gray: And for many people, that question alone can be overwhelming. Oh my gosh, I just got my idea behind me and I'm really excited about. Now I gotta go form some kind of a whatever, but that's okay. It doesn't have to be overwhelming. It really is pretty simple and it takes just a handful of questions. You will need to get some professional help with this. You're going to start hearing things like LLC and S corporation and C Corp and sole proprietor, and then things kind of can feel complicated. So I wanna simplify it, but this today isn't legal advice and I wanna make that clear. You should absolutely talk to your CPA or your attorney before making a final decision about how your [00:02:00] business is structured, because there's law could have ramifications. And great benefits depending on which entity classification or structure that you choose. But I wanna give you today a high level understanding of the most common business structures that you hear about. And so you'll know what the conversations are about when people ask you, and then we'll spend a little extra time. Talking about one of the structures that many second ACT, ACT entrepreneurs choose, and that's the LLC. And we'll go a little bit into detail about the LLC and then how it's tacked as an S corporation, which will make a lot more sense when this is all done. Sole Proprietorship Basics --- Lee Gray: So let me tell you the really the top five. Entities that you're going to be hearing, you're gonna be hearing about the sole proprietorship. The sole proprietor is the simplest business structure. Basically means you're doing business as yourself. And many people start this way without even realizing if you start selling something or offering services that you haven't formally registered you know, a company. You're technically operating [00:03:00] as a sole proprietor. The advantage of that is it is inexpensive to start absolutely simple. Anyone can do it. The disadvantage though is there's no legal separation between you and the business. This means your personal assets could get all mingled up in your business assets if, or your business if something were to go wrong. So for that reason, many people start out maybe with a sole proprietorship and then move on. Beyond this structure, I would say very re relatively quickly. C Corporation Overview --- Lee Gray: The next one I wanna talk about is the C Corporation. Probably don't hear a lot about that and early on you might confuse the C-Corp and the S-corp. But a C Corporation is a traditionally a corporate structure used by bigger companies. The advantages of a C Corporation. Is companies can easier, it's easier for companies to scale significantly. The disadvantage is that it involves double taxation. That means that the corporation pays taxes on its [00:04:00] shareholders and may also pay on dividends. So for most second act business owners, the, this structure is less common. Some C Corps are formed because you can use 401k funds to roll over those into a C Corporation to avoid paying that penalty and tax that comes from just pulling things out of a 401k. Definitely talk to your tax professional. Definitely talk to someone who knows about this in this benefit area because it is complex. But that is one way that a smaller business or a second actor could actually have a C Corporation as their company structure. Partnership Pros and Cons --- Lee Gray: Another one you've heard is a partnership. A partnership is when two or more people own a business together There are several types of partnership, but the idea basically is that. There, it's a shared ownership, and the advantages are you can bring two people together that have different skill sets and they can partner with the com company as [00:05:00] one, but then one contributes a skillset. The other. The other, and then they can both. Contribute capital to the beginning of the business when it starts. The disadvantage to this is that sometimes they can become complicated if expectations and responsibilities are not clearly defined. So you have to have a clear operating agreement. And an operating room is just a fancy word for, I'm gonna do this and you're gonna do that, and we agree and sign it, but it is an operating agreement that is part of. This partnership specifically and is really, really important. No matter how good of a friendship you may have, you must have a written operating agreement if you're in a partnership with someone, because at the end of the day, they're part of you and you are part of them. LLC Why It Works --- Lee Gray: The third one is the limited liability company, LLC. An LLC is one of the most popular structures for small businesses. It creates a separate legal entity from your personal assets. It's easy to start. It's relatively inexpensive. The [00:06:00] advantages are. That it basically has simple languaging. It's simple to manage. The disadvantages are that there's extra paperwork and you have to file some things annually and be consistent with that. And it's a, it does outweigh oftentimes doing the things you have to do for an LLC to avoid the risks that you would have. For combining your, your assets with your business in a say, for example, a sole proprietorship. S Corp Tax Election --- Lee Gray: Fourth is the IS S corporation. You've probably heard S corporation and S corporation's not actually a type of company. It's a tax election, but it gets kinda. Jumbled up into the same thing. Are you an S Corp or an LLC? Well, you're an LLC that decides to be taxed as an S corporation and that. Is an an arrangement basically with the IRS. Many LLCs elect to be tacked as an S corporation because there's potential tax savings particularly around self-employed taxes. And I'm gonna give you an example in a little bit about a company, a [00:07:00] company that I work with that had an S corporation and one that did not have an S corporation, how it impacted their taxes that they paid the disadvantages. Of S corporation stricter rules. You've got payroll requirements. You can't just take money outta the business as as it's your own. There are compliance obligations around how money comes outta the business and other things as well. This is why business owners thinking about the LLC and the S corporations need to work closely with a CPA to decide whether it's a decision or an election that you should make for your business. Amy S Corp Story --- Lee Gray: I promised you, I would tell you a story about an S corporation, and this is it. So this is a company that I will tell you about and we're going to call the owner of the company, Amy, and she started a consulting business in her second act, leaving her corporate career just like many of you. I did, and when she started, she did as most businesses do, she started an LLC. It was simple, affordable, and it gave her some liability protection. In the [00:08:00] first year, she did pretty well. She made around $60,000, which. Felt like business was fantastic. The second year she really started to grow. So she made around $120,000 a year she was on target to to profit $120,000. So here's where the interesting thing happened, because she's operating a standard LLC. All of the plot, all of the profit from an LLC flows through your tax return as self-employment income. That meant that Amy was paying self-employment tax on the entire amount that she made in her business so that all of that $120,000, her CPA sat down with her. We had a conversation together and the CPA said that, ~Karen.~ ~Oops, sorry, not Karen. I, I was gonna use Karen. I changed it to Amy. ~Amy, your business has grown to the point where it may make sense to elect. To be taxed as an S corporation. So now the company itself isn't changed. She's still operating the same business, the same [00:09:00] clients, the same service but the tax treatment's different. With the S election, Amy now pays herself a reasonable salary and there's guidelines for what that is through payroll, which let's say in this case was about $70,000. And then she pays. Employment tax on that 70,000, that salary is subject to payroll tax, right? Like any other employee that she would have. But the remaining profit, the roughly 50,000 that's left over in profit could be taken as a distribution, which was not subject to self-employment tax. So you're basically paying half the amount of tax on that amount after a reasonable. Salary is paid to yourself as an owner. In her case, it saved her several thousand dollars a year in tax and it was a really, really good move for her. And the business had grown enough that the payroll administration was worth it 'cause it's, you know, a little expensive. You gotta do the, the w twos and all of that. When to Switch --- Lee Gray: The lesson here is that. You know, everyone shouldn't [00:10:00] immediately become a a an S corporation. The lesson is your structure grows as your business grows, and you may change your business structure, ultimately one or two times through the process of the life of the business. But many businesses begin as an LLC because it's simple. It's basically a filing, and then you're done. The most important thing is that you don't have to get. Everything done on day one. Second act, business owners listen to me. Many successful business owners evolve the structure over time, and that is okay. Like I talked about the very beginning, a sole proprietorship is fine to start a business. You don't even have to do anything special to start a sole proprietorship. not having elected S corporation status for taxation as an LLC if you're really profitable and. You're going along, taking distributions, thinking, oh, I'm just paying myself a bonus. Company's making a lot of money. You can get penalized for paying that without paying self-employment tax and the tax that goes along with that [00:11:00] Medicare or fica. So it's very important that you, once you get to a certain amount of profit in your business, that you do switch over to the. Election after having a conversation with your CPA because you could end up paying about 30% on all of the profit of your business instead of 15%, which would happen after you have taken a, ordinary salary. Just have a conversation with your CPA about your s selection in LLC, at least in year two of your business, if not sooner, if you have a very successful first year and become extremely profitable. Forming an LLC Steps --- Lee Gray: What it takes to form an LLC, It's really straightforward. It involves registering your business with the state and filing articles of incorporation is just basically what I am, what I kind of a business that I'm in paying a filing fee because the agencies are going to get their piece and then you create an operational agreement and attain an EIN number from the IRS. All of these things can be [00:12:00] done online. You can also do them with the help of an attorney. You can do them with the help of a CPA, but in most states in Kansas, for sure, where I'm located, this can all be done online. I do still recommend speaking with a professional. Remember, your business should serve you, not complicate it. So even when it comes to forming your business structure, let's keep it simple. Okay. Final Takeaways --- Lee Gray: A couple of closing thoughts. 'cause I've, I've thrown a lot at you today. I know I've thrown a lot at you today. And for those of you who are thinking about starting your second act, or maybe you have, and now you're thinking really, where's the structure? It's easy to get overwhelmed with business details like that. Like Remember this, these decisions are important, but. They are not the thing that makes your business successful. The thing that makes your business successful is creating value and serving people, serving them well and continuing to take action. Your structure can evolve over time. Go ahead and get started. [00:13:00] Your ideas will grow Your second act will take shape and you can build on that. Don't let the paperwork stop you from starting. what a great. Conversation today. Reviews and Support --- Lee Gray: Thank you for being here with us and be Before we go, I have something I wanna to ask you. You know, we we're, this is episode eight, we are eight episodes in, and we are so proud of what we have accomplished. I believe I'm doing what I'm passionate about and that's helping entrepreneurs, people like you, gives me a lot of energy and, and happiness To do that, in order to get this message further, we need your help. Could you, would you, if you listen to us on Spotify or on Apple, please leave us a review. It helps us Apple and Spotify. Take it upon themselves to show us and share us with more people when we get more reviews. That's why it's really, really important that we get the reviews and for any of those that you give us, we thank you in advance. We'll help, we will help other entrepreneurs [00:14:00] together. If you watch us on YouTube. Please leave a comment and a thumbs up for us. Follow us on YouTube. We'd love to have you come along with us on this journey and share us with other people so that we can help other entrepreneurs and those who are interested in their second act, be successful in their second act as well. Dont Overcomplicate --- Lee Gray: after this conversation with you, my final message is this. Don't overcomplicate it. Don't overcomplicate any part of starting your second act, and that's what I feel like expressing. What do you feel like expressing?