This is a good checklist, but I have observed that corporations with a "history" have value on their own. It is perhaps less well known than other parts of the equation, but when I created my first LLC it was a pain because as a "new" entity it had no credit history, no existence history, and every time it raised a bunch of flags with every new vendor. Once it had been around for a few years it was fine. When it came time to dissolve it I had a choice of just dissolving it, or selling it to a agent (typically a lawyer) after detaching myself from it. In the latter case that is the standard public notice of sale and disclaimer of association past the sale date between me and the company.
When starting an LLC it can be advantageous to start with one that is 'on the shelf' as it were because it avoids the this is all new company unpleasantness. Most agents have a number of ambiguously named LLCs available for people who want to assign a holding company for trusts etc.
Given that California charges you $850/year just to exist as an LLC it isn't profitable to create and hold such companies just to sell, but when it is time to sell there is some value there sometimes.
I've heard of this in the context of shortcutting regulatory stuff - if you want a banking license, find a small bank in some backwater and "merge" with them, if you want to list on a stock exchange, find a small, cheap listed company and do the same. You obviously need to maintain the regulatory compliance framework, but in many cases, this is cheaper and simpler than getting a license or listing on an exchange from scratch.
Anyway, it surprises me that someone who cares enough to be suspicious of a newly formed LLC doesn't care enough to check that a given LLC is an empty shell that changed ownership very recently. If anything, you'd think that to be more suspicious, wouldn't you?
Side note: Isn't this the impetus behind Stripe Atlas? It at least allows you to have many of the necessary banking and management functions right off the bat.
Thank you for this. I'd also love to see something similar for a DE C-corp since that's the preferred incorporation method for startups... then again, that might be very case specific if you have investors.
Very case specific, yeah. The general process is the same after you get to the resolution part, I imagine, but distributing assets might end up being trickier
Appreciate you sharing this, and glad to see it's for a good reason.
For anyone considering forming an LLC S-Corp for their consulting/freelance business, don't let this scare or deter you.
I've been running mine for over five years (I'm a consultant) and it's been mostly painless. I use Freshbooks for accounting and Gusto for payroll, so there's actually very little overhead day-to-day.
The key thing for me was to find a great accountant. I went through two accountants before finding someone who's right for me. That has made a huge difference in how much I worry (or don't) about that part of the business.
Yeah, the S-Corp is a fine entity choice for consultants and other small businesses that have above six figures in profit. It’s not good for side projects because, while overhead is low, it’s still not nothing.
Some experiences with this in my personal capacity:
You want someone who has a working style which is compatible with your working style. There are a surprising number of accountants who cannot reliably receive a folder that has been Dropboxed to them. Some of them are good accountants... for other people. If you are e.g. an email person, you do not want a phone person accountant. You want an accountant where neither of you are annoyed with the other's expectations with regards to timeliness of replies to emails.
You want someone who is capable of understanding the fundamental nature of your business. They don't have to be able to _operate_ the business, but they need to _deeply_ grok the mechanics of the business, because accounting is a facts-intensive profession and they need to understand your facts to apply GAAP and IRS procedure (etc) to them. You can be a great small business accountant without knowing what the difference between SaaS, Github Enterprise, and Microsoft Word is; you cannot be a great accountant for a software company without being able to understand the differences in those three products.
You want someone who is generally good at accounting. Like any other profession, there is a competence curve. Don't hire the people at the left end of the competence curve. You want someone who is good at being a professional, partly because that will make interfacing with them easier and partially because a portion of the services of an accountant is to suit up occasionally and say "I am an accountant." to third parties. You want someone who can cause the appropriate reaction there. (Most commonly tax agencies, but there are a variety of potential counterparties, for example e.g. mortgage lenders, prospective landlords, immigration agencies if that is relevant to you, business counterparties, etc.)
Some of y'all might have interesting situations, and very interesting situations often counsel having a specialist. A particular interesting situation which I have in my life is that I'm an American who lives in Japan; that fact substantially complicates accounting for my businesses or personal life, both with regards to tax preparation and with regards to just giving good financial advice, and I get far better results working with people who specialize in international clients than I get with (presumably) skilled accountants who are willing to work with international clients but don't wake up and breathe the US Japan Social Security Totalization Agreement.
More relevantly to HNers, I think that you probably have special circumstances if: you do a material amount of investing in things that your average dentist does not, you own a material amount of equity, the character of your life is intrinsically international, etc. (Running a business is its own flavor of complication.)
The first one did not specialize in small business, so he did not give me any specific advice. The second one was a bad communicator; took too long to respond, if at all, and did not fill me in completely on what he was doing.
The one I use now responds quickly to any questions, makes sure I understand what’s happening, and proactively offers suggestions.
It's pretty fucked up that people do this, and if running this particular tax dodge complicates people's lives, God bless the bureaucracy. You should not get to underpay payroll taxes, roping off a big chunk of your income as "profit sharing", simply because you happen to own an S-Corp. I've heard this is a big audit flag, but even if it wasn't, I think doing it is pretty close to immoral.
First, there are no morals involved in taxes. I don’t make the tax laws and I have no responsibility to pay more tax than I owe. If Congress wanted to close this then they would. I believe it was a plank of Hillary’s campaign.
Second, there’s a very narrow window where it actually makes sense. Above $128k of salary you don’t pay Social Security tax at all, just Medicare. “Underpaying” social security reduces your future annuity, so it’s not like this is a panacea.
Third, paying yourself zero salary and taking profit sharing distributions is indeed a massive audit risk. I’ve never done that and don’t ever plan on it (see: article title).
Right: that narrow window is what makes it so crazy-making. Virtually everybody who employs this dodge is comparatively privileged. Most people don't get to opt a big chunk of their income out of Medicare/Social Security taxes; why should tech company operators?
We're an LLC filing as S-Corp, for what it's worth. I just don't play this particular game.
I am all for Congress removing this as a benefit of S corps and simultaneously removing or significantly lifting the Social Security wage cap. That’s a thing I would vote for. Until it happens, though, people are going to continue doing this. Congress removed a similar dodge for C corps almost 80 years ago, so it can certainly be done.
S corps aren’t just used by consultants, FWIW. The structure makes a lot of sense for companies with lots of profit and more than owner employees, where the owners can justifiably claim they don’t generate all the profit from their personal services.
The whole idea of "profit not generated from personal services" that are exempt from Medicare taxes is what's problematic. If you own a company and make six figures in income from it, you should be paying taxes on it as regular income. Medicare and Social Security already have a break for high-income earners --- the income limit you previously mentioned.
I don't know that we really disagree about any of this; I'm just ranting. It upsets me that people think this is legitimate and exploit it, or that "Mr. Money Mustache" would promote it.
Medicare doesn’t have the same income limit. In fact, Medicare has an additional bracket above $250k earned income.
We agree that it’s not a great legal outcome. I just don’t see it as something worth getting outraged about. The number of people truly exploiting this system is very small, and the ones that are egregious get caught.
Thanks for all the comments on this - I really had no idea it would be this controversial, was just curious (and wondering whether to be more creative with corp stuff for my next project, mostly whether I grown up enough to have Inc. suffix on it, rather than LLC)
In the past, the "reasonable salary" requirement wasn't even there, the guideline was something else along the lines of distributions being triple the salary or less. The IRS came out with the "reasonable salary" thing after that point, which suggests to me that as long as people are paying themselves a reasonable salary, the IRS does not see this as an abuse of any sort.
If you want to consider it immoral compared to your own values, go for it, but it's pretty mean to call it a "tax dodge", or fucked up for others to do it.
Just for a data point - I had a few years of ignoring distributions, and shopped around last year for different accountants. I talked to five, and every single one of them recommended I shrink my salary to "reasonable" and pay myself more distribution. It is not a shady practice.
I see... I’ve been using llc’s without s corp for all my consulting and side projects for a while (easy to start and kill them off). It looks like S corp does add quite a bit of overhead though - although maybe it lowers taxes? Is that the reason?
You can significantly lower your SE taxes due (Social Security and Medicare) by giving yourself a salary lower than your profit. This comes at a cost of additional overhead (payroll and an accountant to prep the tax form, which is not a DIY project for at least the first year). There’s a threshold of about $100k profit where this begins to make sense.
Varies considerably by state. In Michigan business owners are not eligible for unemployment. They also don’t pay unemployment tax for themselves or family members.
Not trying to be an ass, but my understanding, as the owner of an S corp, if you are paid as a W-2 employee, you are eligible for unemployment benefits.
I only see 7 states that prohibit this, and Michigan is not one of them:
Unemployed worker performed services for a PARTNERSHIP of which any part is owned by the unemployed worker, or 100% which is owned by any combination of the following:
* Unemployed worker
* Unemployed worker’s child(ren)
* Unemployed worker’s spouse
* Both of the unemployed worker’s parents, if unemployed worker is under 18.
On page 2, the document goes on to say that owners of a corporation are entitled to limited benefits. They have to pay in to UIA, however. As the owner of an LLC I didn't have to pay into UIA at all for myself or family employees (and in fact got a refund when I mistakenly paid in).
When starting an LLC it can be advantageous to start with one that is 'on the shelf' as it were because it avoids the this is all new company unpleasantness. Most agents have a number of ambiguously named LLCs available for people who want to assign a holding company for trusts etc.
Given that California charges you $850/year just to exist as an LLC it isn't profitable to create and hold such companies just to sell, but when it is time to sell there is some value there sometimes.