Discover how to choose a business entity for a new business in a real-world situation. This is the start of our ‘Sam’s Story’ series!
The ‘Sam’s Story’ Series
Many people aren’t sure of what being a regular client of an accounting firm looks like. How can your accountant help you on a daily basis? What’s the process look like for many typical accounting and business tasks? To help illustrate these topics, I’d like to share with you the story of Sam. We’ll be covering a wide variety of accounting topics in the coming months – using Sam’s story as a basis.
Meet Sam, a typical client of Gift CPAs.
For years, Sam has been a client of Gift CPAs for his personal tax returns and tax consultation on his retirement accounts.
Sam is your typical neighbor. He is married with two children and works as an Operations Manager for a local company.
One spring afternoon Sam gave me a call and wanted to schedule a meeting to discuss a potential business opportunity and career change. Our story begins here.
Buying a Business
Sam got a hot tip! A local sports bar in town was up for sale. His long-time declaration of, “One day, I’m gonna own a big Sports Bar!” resonated in his wife’s mind.
He sat before me looking for advice on how to evaluate the decision to buy this business and what he needed to think about before leaving his current position and working for himself.
No easy answer, no short cuts, but anything worth doing…
I started with a complete financial review of the business with Sam. This included reviewing the past 3 years income tax returns and financial statements. Sam also inquired about creditors or taxing agencies that may have had liens on any assets.
The financial review did not turn up any skeletons so I turned Sam’s attention to the capital his business would need and the capital his family would need during this transition.
Once Sam and his family became immersed in the concept, I then began discussions on financing the purchase, tax strategies and an asset sale vs. a stock sale. Some of these topics will be discussed in future blogs.
Selecting an Entity for that Business
Some time has passed and Sam has successfully opened Sam’s Sports Bar, LLC. Since our firm, Gift CPAs, has been doing his taxes for a number of years, he had come to me to help him get started with setting up the business. With all the tax changes coming out of Washington these days, he wanted to be sure that the type of business entity he chose would be best for his situation.
Business Entity definition: An entity is the specific business structure you choose for your organization, each entity coming with unique legal and tax implications.
He asked which entity I would choose if I were him. After quickly going over them in my mind, I recommended that his business be taxed as an S corporation. I explained that an S corporation’s main benefits were liability protections against certain creditor situations, no potential double taxation if he would sell his business in the future, and the ability to save some payroll taxes (dependent on the services he provided to his company and what his other employees were paid, among other factors).
A second option would be to do business as a sole proprietor, which would be the easiest way as far as record-keeping goes, but there were some definite drawbacks to this option. First of all, there would be no corporate protection for his personal assets. Also, all of his profits would be subject to self-employment tax (Social Security); with an S corporation set-up, it was possible that some of the money he would take out of the business would be considered distributions, which would not be taxable for self-employment. There were too many potential drawbacks with this option to suit me.
If he brought in his wife, Cathy, or possibly a friend of his, maybe Mark, to form a partnership to own the business, the same disadvantages as a sole proprietorship would still exist, since a partnership for tax purposes is basically a collection of individuals. Most of the same tax benefits and drawbacks apply in either situation.
The other option was a C corporation. They used to be popular back in the 1980’s, but a change in the law made it probable that upon the sale of a business, there would be double taxation (once at the corporate level and once at the personal level). This major change dried up the market for new C corporations.
I could see that Sam was satisfied that my original answer of being an S corporation was the best option for him. He contacted the attorney to take care of filing the necessary paperwork to make this happen.
Within a short matter of time, all the paperwork was done and Sam’s Sport Bar, LLC was up and running as an S corporation and Sam was relieved that at least this aspect of starting his business was handled correctly.
Don’t Miss Part 2 of Sam’s Story
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