Dear Cynthia,
Well, I am so glad that you mentioned that you're in California.
It makes all the difference. California is the one state where you
do NOT want to be an LLC. California has a gross revenue tax on
LLCs.
What does that mean? It means you are taxed on the raw income of
of the business, before any expenses are deducted. So, even if you
have a loss for federal income tax purposes, you might find yourself
paying California's Franchise Tax Board over $10,000 a year.
If you want to protect your friend's assets, you must form either a
corporation or a Limited Partnership (LP). Both are subject to California's
minimum $800 annual fee.
The LP only pays $800. period.
The corporation pays 9.3% of profits.
Unless the corporation is an S-Corporation.
Then, it only pays 1.3% of profits.
In the LP, your friend would be the limited partner.
S/he is protected. Except if she runs one of the sites.
Then, s/he really stops acting like a limited partner.
So, the LP is out.
Let's look at the corporation.
You might want to discuss this in further depth with a good
local tax professional. Expect to spend about two hours with
them to go over all the details. You really need to do that,
giving them the whole picture, your goals and each of your
personal financial structures. Expect to spend between $300
to $600 for the consultation.
In general, though, I think you could form an S-Corp.
The taxes are lower for California, none for IRS.
You could both own the stock 50-50, or in whatever proportion
you think is fair. Your capital could either go towards giving
you a higher ownership percentage, or partially towards stock
and the rest towards a loan to the company.
Since you are doing the bulk of the work, you would take a
substantial salary (yes, wages) commensurate with the time
you're putting in. Your friend, if s/he's working on one of
the sites must take a salary, too.
Once your wages are deducted, and all the other expenses are
deducted, the rest of the profits will be reported on your
personal tax returns, just like partnership income would be.
It won't be subject to self-employment taxes (15.63%) so, that's
a big plus.
I hope this helps.
Your TaxMama-ga |
Clarification of Answer by
taxmama-ga
on
19 Jan 2004 08:29 PST
Dear Cynthia,
Sorry to keep you waiting for an answer.
I've been out of town.
You asked:
"Can you provide a clarification on what tax advantage incorporation
has over an LLC?"
In California?
The biggest advantage is that corporations do not pay the gross receipts tax.
That's the additional tax LLCs pay on their revenues, if they gross over $250,000.
http://www.ftb.ca.gov/forms/misc/3556.html
If you're never planning on having revenues that high, don't worry about it.
Corporations pay tax only on their profits. Which, in many cases, tend to
be low, with proper planning.
Other than that, there may be some payroll benefits and retirement program
benefits that you can have with a corporation that you can't as an LLC.
Disadvantages of a corporation over LLC?
If you file as an LLC first, you may not have all the stringent minutes
and record-keeping requirements that you have with a corporation.
Personally, I feel that if you keep those minutes, or those notes, it will
help you and your partner keep your relative duties and benefits defined.
So you should spell those out anyway. (Trust me, in the long run, that helps
keep relationships intact.)
You asked:
"Tax forms for an LLC
Thus, I understand that the LLC would be taxed as a partnership"
As I said originally, you may CHOOSE to tax your LLC as a partnership.
You may also choose to tax it as a corporation. That's up to you and
your tax advisor.
Here are the California forms you'll need to file.
http://www.ftb.ca.gov/forms/misc/3556.html#2
For IRS, you will need to file the Form 1065 and related K-1s,
if you choose to be a partnership.
If you choose to file as a corporation, you will use Form 1120.
If you choose to file as an S-Corp, you will use Form 1120-S and the related K-1s.
You ask:
"Liability
You state that my friend "is protected" under an LP (limited
partnership). However, my understanding is that my friend is **NOT**
protected should we form an LP.
http://answers.google.com/answers/threadview?id=86111
Please explain how my friend is protected under an LP."
I said:
"In the LP, your friend would be the limited partner.
S/he is protected. Except if she runs one of the sites.
Then, s/he really stops acting like a limited partner."
In other words, as long as your friend remains a silent partner,
s/he is protected in an LP. The minute your friend is actively
involved in the business, i.e. running a site, s/he is no
longer protected. That's why I said "the LP is out."
You asked:
"S-Corp
In reference to federal taxes, what do you mean "none for IRS"?
Please clarify this point."
None = $-0-.
IRS does not tax S-Corporations. They also don't tax partnerships.
All the income from these entities are reported on the owners'
tax returns. They flow through to you via the K-1's.
California has the minimum tax of $800 on S-Corporations, plus
1.5% of net profits.
California has an $800 minimum tax on LPs, no minimum on General Partnerships.
Cynthia, you're doing a good job researching all the issues.
But take the information you've found and DO sit down with a good California
tax professional in your area. They will know about your local issues and
industry issues. In addition, they'll be able to meet with you and your
partner face-to-face to determine how to address the personal financial issues.
You already have enough information to take a list of your issues and concerns
and to be able to limit your consultation to an hour or two. DO tell them that
you don't want them to start explaining from the beginning, but that you want to
start with them simply answering your questions.
You'll need someone good on your side if your business is to do flourish.
So this is a good way to start the relationship.
And hey, who knows, with Uncle Arnie in office, he may improve the environment
for business someday. Don't hold your plans waiting, though.
Best wishes
Your TaxMama-ga
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