Consulting/LLC or Corp Experience

[Patrick Fleming EA]

On Mon, 22 Apr 2002, David P. Schwartz wrote:

> 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).  

If you have a corporation that relies upon you to perform services as a 
consultant and there are no employees and 50% of your income will be from 
services (rather than products) then your corporation is defined as a 
Personal Service Corporation (PSC) subject to a flat 35% tax rate on all 
undistributed income.

>You can borrow
> money from the Corp rather than take it as income, 

See above.

>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.  

I have not seen this type of audit in recent years. This biggest problem 
in this area is not strictly following the home office rules.


> ... 
> 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!

7.5% of Adjusted Gross Income.

> 
> The main difference is that personal income is taxed BEFORE deductions are

Not true. Income tax is applied to the amount left after subtracting 
personal and dependent exemptions, and your itemized or standard 
deduction- whichever applies.

> 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. 

Net Operating Loss applies to individual returns as well as any type of 
other entity. The carryback period is 2 years and the carrover period is 
20 years unless you elect not to carryback (or Bush signs another bill 
with NOL rules in it)

> 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

If it's a PSC it pays 35% on any net profit.

> 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.)

An S-Corp is a separate entity and must keep separate books, bank 
accounts, etc. and is most like a C-Corp when it comes to keeping books. 
Profits and (some, but not all)losses flow through to your personal return 
for income tax purposes. Most S-Corps do not pay income taxes although 
there are a few that do pay certain taxes on built in gains, or for 
investment income if it exceeds a certain percentage of gross income to 
the corp.

> 
> 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

Some accountants can give you excellent tax advice, but they are licensed 
first and foremost as auditors and book-keepers. They are required to 
maintain continuing education in their primary field. Few will actually 
specialize in taxation, although that is the general public view of CPAs. 
Do not interprete this to mean there are no good CPAs when it comes to 
taxation, it means that most specialize in accounting, auditing, and 
consulting. If you want someone who only concentrates on taxation find and 
Enrolled Agent. Enrolled Agents are licensed by the IRS after passing a 
four part exam proving tax knowledge and a background check. CPAs are 
licensed by each individual state (and must ask permission to move the 
license to each state they want to work in) and must pass an exam proving 
knowledge of accounting procedures established by NASBA and the AICPA with 
some taxation included. If a CPA suits you better, and there are arguments 
both ways, then find one who does specialize in taxation for your tax 
questions.


> 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

Those rules are in place to protect the general public.

> 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
> >
> 
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-- 
Patrick Fleming, EA
http://myhdvest.com/patrickfleming
Licensed to represent taxpayers
before Exam, Appeals, and Conference 
divisions of the IRS