Choosing the right structure
One of the most critical decisions you can make in business is deciding what structure best suits your entity. Both the internet and social media are often filled with conflicting advice, with some gurus recommending an S corporation while others advocate for limited liability companies or C corporations. Understandably, this conflicting advice causes confusion, especially when posts containing incorrect information receive significant engagement—giving the illusion of credibility and further validating poor advice. In this article, we will break down entity planning and provide insights on what you need to think about to determine what structure best suits your business.
What is Entity Planning
Entity planning involves deciding on the proper legal structure for your business. Keep in mind there are many factors at play here; tax efficiency, future investment, and asset protection all play major roles in the decision.
Understanding S Corporations (S-Corp)
Many people suggest forming an S corp due to its tax saving potential. Here’s how it works:
- If your business operates as an LLC, makes $100,000 in gross revenue, and has $20,000 in expenses; your net income is $80,000. As an LLC, The Entity will pay self-employment taxes ( Social Security and Medicare) at around 15% on the entirety of the $80,000.
- Conversely, by electing to be taxed as an S Corp, you can instead take a reasonable salary and classify the rest as a K1 distribution (distributing profits to ownership). For example: you’d pay yourself a $30,000 salary and take $50,000 as a K1 distribution, saving yourself 15% on your K1 distribution ($7,500 = $50,000 x 15%).
The best part; the more the revenue increases, the more the tax savings become. For instance:
- Let’s say your business generates $1 million in Revenue with $200,000 in expenses, leaving you with $800,000 of net income. As an LLC you’ll be paying 3% Medicare tax which should cost you around $24,000.
- However, electing an S corp status would allow you to pay yourself a reasonable salary (e.g. $200,000), which would reduce your Medicare tax exposure on the remaining $600,000. This results in a savings of around $18,000.
- If your Revenue reaches eight figures; let’s say $10 million with $8 million in net income, electing an S corp status would provide substantial tax savings.
When Should You Consider a C Corporation (C Corp)?
There’s often a common debate around a particular downside of using C corporations; double taxation. Double taxation refers to the fact that a business owner would pay taxes on both corporate and personal levels.
Now you may ask, why would anyone ever choose a C Corp? A C Corp can be beneficial if:
- You are scaling your business and plan to take on outside investment
- You need stock options to attract top-tier talent
- You plan to reinvest your profits into growing the business rather than distributing profits back to ownership
- You want to leverage tax strategies for a future exit or IPO
With all of that said, an S corp is generally a better choice for small business owners with no plans for rapid expansion or exit.
Trusts and Business Ownership
Some online sources suggest business ownership structured through a trust. Before making that decision it’s critical to understand the difference between revocable and irrevocable trusts:
- Revocable Trust: Putting business ownership into a revocable trust offers no asset protection nor tax benefits but will help to avoid probate during a transfer.
- Irrevocable Trust: An irrevocable trust removes assets out of your taxable estate, and provides asset protection, but also reduces your direct control over the business; seeding control to a trustee you appoint. From that moment on, the trustee is empowered to make decisions on the assets of the trust, and will do so with a fiduciary responsibility to the beneficiaries. While you should appoint a trustee that you trust and who will listen to you, there can be occasions when that trustee will act against your wishes, often leaving you without recourse to do anything.
Structuring Your Business Correctly
As you might have guessed by now, choosing the right business entity is not a one size fits-all decision. Various factors including income level, business goals, and tax strategy all play their part. By structuring your business correctly from the beginning, you should put yourself in a position that allows you to save money, protect assets, and build a sustainable financial future.
Contact Us
If you need personalized guidance, the team at Neil Jesani Advisors is here to help you make the right choice. Our team is composed of highly experienced Certified Public Accountants (CPAs), IRS Enrolled Agents (EAs), tax attorneys, CFOs, and controllers—all working together under one roof at our office in Sunrise, FL, just outside Miami. With over 350 years of combined expertise, our 40+ professionals serve clients nationwide, with a strong presence in California, New York, New Jersey, Illinois, Florida, and Texas.
Our clients generally fall into two categories:
- High W2 earners (executives, engineers, and professionals) who make more than $2 million annually.
- Small business owners, including those in the medical, legal, dental and IT sectors who net at least $2 million per year.
Beyond income tax planning, Neil Jesano Advisors also specializes in entity planning, asset protection, estate tax strategies, wealth preservation, and legacy planning.
Schedule a free consultation today and create yourself a better tomorrow.
