Consulting/LLC or Corp Experience

[David P. Schwartz]

Austin,

It can be very advantageous to have a separate legal entity set up for your
business.  There's a common misconception held by the accounting community
that you need $50k or so income before it pays to have a Corp or LLC, which is
very misleading.  Say you make $45k profits (not income, but profits) -- as a
proprietor, that could be taxed around the 35% tax bracket, while everything
under $50k to a Corp is taxed at 15% (both Federal tax rates).  You can borrow
money from the Corp rather than take it as income, and you can have the Corp
pay for stuff that's fully deductible to the Corp but more difficult to
justify if you try claiming it on a Schedule C.

For example, I've been told by several sources that the mere existence of an
in-home office deduction on a personal tax return (through Schedule C)
increases your chances of being audited by some 50x.  It was explained to me
that this is mainly because people like to take the deduction, but then they
fail to make the corresponding reduction in the cost basis of their home later
on.  The deduction is designed to be recaptured at the time you sell your
property, and you may have to pay tax on it then.  (Why you'd want to take a
deduction against an appreciating asset anyway is something else you'd want to
discuss with your CPA...)  However, you can perform work under contract to
your Corp and have the Corp reimburse you for "overhead" (built into your
contract) without triggering the audit or messing with the cost basis of your
home.

Your insurance and overhead "expenses" are pretty much going to be the same
regardless of how you incur them.  However, your Corp can provide a benefit
where you can get reimbursed for medical expenses that are not covered by
insurance  (just be sure it doesn't discriminate among classes of employees).
On a personal return, you cannot even deduct non-reimbursed medical expenses
until they've exceed something like 2.5% of your gross income!

The main difference is that personal income is taxed BEFORE deductions are
applied, while business income is taxed AFTER expenses.  Also, if you are a
"sole proprietor" using Schedule C to account for your business expenses,
whatever is leftover after deducting expenses is plopped right onto your
personal 1040 as ordinary income, and you cannot deduct losses that exceed net
income, nor can you carry the losses forward in the same way as for a business
entity.  For a C Corp and LLC, the company has to actually PAY you something
before it's considered personal income to YOU; they pay taxes on something
like "unallocated retained earnings", for which there is no equivalent if
you're a sole proprietor.  (That is, the business can legitimately set aside
some amount of retained earnings for expansion and future needs without
incurring a tax liability on those earnings.  If you're a sole proprietor,
your only option is to pay the tax on the income FIRST, and then stick it into
a savings account or something, as well as pay further taxes on any gains made
while you're waiting to use it.)

I think an S Corp is like a proprietorship for most accounting purposes with
the legal liability protections of a C Corp; I've been told that S Corps are
best if you're expecting losses for a few years and you've got lots of taxable
income that can be offset by the S Corp business losses.  All Corps start out
life as C Corps; you can elect to switch to S Corp accounting once, and I
think you might be able to switch back once, but that's it. (Check with a CPA
for details.)

Get your hands on some of the books by Robert Kiyosaki ("Rich Dad, Poor Dad",
"Cash-Flow Quadrant", "Tax Loop-holes of the Rich", etc) and look them over.
They're EXTREMELY EDUCATIONAL!

NOTE: I'm not a CPA, just some guy who's spent some time studying the Tax
Laws.  I don't keep up with the latest changes; that's what CPAs are for.

Just a few words of advice: nobody has as much of a vested interest in your
financial situation as YOU do.

Accountants can give you tax advice, but the line gets very fuzzy when it
comes to asking them for advice on how to best structure your business because
that gets into legal areas.  I've had questions about business structure
strategies that CPAs say are legal issues and attorneys say are tax or
securities law issues; neither one is willing or often able to answer some of
these questions directly or clearly.  For these, you want to search out people
who specialize in "asset protection strategies", and they typically are
neither CPAs nor Lawyers, simply because there is useful and valid advice they
cannot give if they have to operate within the constraints of a "government
license".

(For instance, anybody with a NASD Securities license is prohibited from
discussing anything having to do with strictly off-shore investments.  Not
because they're illegal per se, but because the jurisdiction of US Congress
does not extend off-shore, so as far as they're concerned, "off-shore IS
illegal" -- it's off their radar and they can't regulate it, so licensees
can't discuss it.  For instance, there's nothing wrong with trading Japanese
securities in Japan, just don't try to do it in the US, because the US doesn't
have legal jurisdiction over Japanese securities.  There are the financial
equivalent of "gender benders" to "convert" such foreign securities into
legitimate US-tradable securities, but ironically they're not Japanese at that
point and you cannot trade them in Japan!)

--
David

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> Hello,
>         I was wondering whether anyone on the list has had experience with
> doing independant contracting and using a LLC or some form of
> corporation rather than just doing it as an individual.  Are there
> advantages?  What additional overhead and expenses?  Insurance issues,
> both personal health insurance and job related?
>
>
> Thanks,
> Austin
>