Operating as a sole proprietorship is the least complicated way to run a business. But, is it the best way to run a business?
The Simplicity of a Sole Proprietorship
In the eyes of the IRS and state taxing authorities, a sole proprietor has full responsibility for his or her business. That’s good for owners who want simplicity. Owners can comingle their business assets with their personal assets. All revenues earned by the business and expenses paid by the business can be deposited into or written from the personal checking account.
Generally, no special filings need to be made with the department of state or revenue when a sole proprietorship is used.
Why Would Someone Prefer Operating as an LLC?
To limit personal liability. When one operates as a sole proprietor, the business owner is personally liable, meaning his or her personal assets and savings can be at risk. Incorporating or forming an LLC generally protects the owner against personal liability.
To establish business credit and get funding. Once you form an LLC (or corporation), the business itself begins its own credit profile.
To give your business more credibility. Adding an LLC or Inc. after your company name boosts your credibility in the eyes of some customers and vendors. In fact, a formal business structure is required in some industries to win certain contracts. Some businesses are more comfortable hiring a business than a sole proprietor to do work for them.
Potential tax benefits. Sometimes, corporate tax rates are lower than individual tax rates. Plus, there are additional tax benefits and deductions for corporations that are not available to individuals. By incorporating, you’ll lower what you owe in self-employment taxes.
What Are the Negatives of Creating an LLC?
Negatives of operating as an LLC include, but are not limited to . . .
Registrations with the state department of state and department of revenue are usually required.
A separate set of books and records will be required. The business owner (in most cases) will not be able to comingle business revenues and expenses with the owner’s personal checking account.
If the LLC needs to borrow from a bank, the loan will be treated as a commercial/business loan and not as a personal loan, resulting in an increased loan interest rate being charged.
Tax Tip #1
A business owner can create their own LLC using one of the many Internet resources available. However, before doing so, the business owner should consult with an experienced tax professional AND business tax attorney. Tax professionals do not know all of the nuances of the legal law and regulations, and likewise attorneys generally are not well-versed with the federal and state tax rules and regulations.
LLCs can operate as a sole proprietorship (if only one owner), a partnership (if two or more owners), and as a corporation (regardless of the number of owners). An LLC electing to be taxed as a corporation can be taxed as an S Corporation by timely filing IRS Form 2553, or as a C Corporation. An experienced tax professional working with your historical financial records or your 5-year budget plan (if a newly formed business) can best advise you which type of LLC legal entity best suits your business.
Tax Tip #2
Although sole proprietors can comingle their business revenues and expenses with their personal checking account, that is never a good idea for several reasons. If audited by the IRS or state, the audit will be more simplistic if the LLC’s financial records are kept separate from the personal financial records. If the finances are comingled, the audit of the business will by necessity include that of your personal finances. Also, the auditor will likely want to classify every deposit in your personal checking account as LLC revenues unless you can prove otherwise. Will you be able to recall every deposit in your checking account two or three years later when the auditor shows up, and will you be able to prove the source of that deposit as not being business related? Keeping the books separate eliminates so many potential audit issues.
When it comes tax preparation time, it is important that the business transactions are easily and readily identified to prepare a complete and accurate business tax return.
Should you decide to sell the business, the buyer will want to see the financial records to verify the business activity. Likewise, the seller will not wish for the buyer to see his/her personal finances. Short order – keep the business financial activity separate from the personal checking account.
If you would like to discuss your business or personal tax planning, tax preparation and other financial If you have been using the IRS has a bank to hold your overpayment,concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.
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BE SURE TO READ THE DISCLAIMER PAGE: Tax laws, IRS rules and regulations change frequently. Although we hope you’ll find this information helpful, this blog is for educational purposes only and should not be considered as the rendering of tax, legal or investment advice. The publisher shall not assume liability for any losses, injuries, or damages from the display or use of this information.
About F. Bryan Haarlander, EA, CTRS:
Bryan Haarlander is an IRS licensed Enrolled Agent and who owns and operates a specialized tax services firm serving clients in the western suburbs of Philadelphia, PA, which includes the cities of Chester Springs, Coatesville, Collegeville, Devon, Downingtown, Exton, Frazer, King of Prussia, Paoli, Philadelphia, Phoenixville, Pottstown, Radnor, Reading, Wayne, West Chester in Berks, Chester, Delaware, Montgomery and Philadelphia Counties, as well as clients in Delaware, New Jersey, New York and throughout the continental USA.
A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.