LLC vs Sole Proprietor: Which is best for YOUR business?

a friend graham cochran here one of the biggest questions I get as a business coach is really simple should I run my business as an LLC or as a sole proprietor maybe you've asked yourself that question if you're trying to figure out which entity makes sense to you from a tax perspective or maybe you're just thinking I don't know what the heck either one of those are or why I should care I'm just making money or trying to make money believe me I've been there and what I hope to do in today's video is explain what each one of those are and the differences and give you a simple and easy framework to understand which one is the right fit for you and your business - huge preface is before we begin number one is I am NOT a licensed tax professional I can only give general advice to you based off of my experience and what makes sense as a business coach I don't know your specific details so it might make sense to consult your CPA or your tax advisor if you have more detailed questions and second all of this content makes sense for you if you run your business in America this is the country I live in and work in and it's the tax code I understand so I'm gonna be speaking specifically to the American tax code make sense all right let's jump in sole proprietor LLC what the heck are these things in the plainest terms possible a sole proprietor is what you are by default when you start rendering a service or selling a product whether you know it or not the moment you open up shop as it were and start making money you are at least in the IRS --is eyes a sole proprietor there are no forms to fill out to become a sole proprietor there are no hoops to jump through it is just who you are by default and that phrase sole proprietor means simply this you are a one-person business or a one owner business sole meaning only and proprietor meaning or property owner easy-peasy so what does this mean for tax purposes by law if you make any money on the side with your side hustle you know I hate that word you must report that income on your tax regen if you want to be legal at least and you should because it's the right thing to do the many people run small side businesses whether it's cutting grass cutting hair designing websites whatever and they think they don't need to report that income if it's under a certain amount now if you make any money report that income on your personal tax return now the way the IRS views this income as side income is really simple they tax that income which is really your income minus your expenses so they attacks your profit like any income you make at your personal tax level so your personal tax bracket the same amount your tax on any paycheck you currently have so your tax at your same personal tax bracket plus something called self-employment tax which is at this moment 15.3% and this includes your FICA the Social Security Medicare all that kind of stuff so your personal tax bracket whatever that percentage is for you on the federal level and your extra fifteen point three percent self-employment tax now if you live in a state that charges state income tax you'll have to pay that as well not all states do but some do so you'll want to take a look at what that tax is for your state then we'll talk about how to file your taxes as a sole proprietor in a minute but in essence that is what you are by default you're making side income whether it's $10 or $10,000 you need to report it and there's a place for you to do it and that is how you're taxed on it now an LLC stands for limited liability company and it's exactly what it says it is a company that you form that has limited liability for the owner basically you're setting up a separate entity that runs the business that does the business that isn't you you own that entity and you might work in that entity but you are not it it is separate from you which comes in when things like lawsuits come about it keeps a separation a veil or a wall between what can be sued and what can happen over here and your personal life and your personal wealth and your personal assets and things like that now the big difference between the sole proprietor in the LLC besides having that separation the big difference as it relates to you and your taxes is that an LLC has to file its own tax return because it is its own entity separate from you so has to file its own return and then the profits which is all the income that business made - its expenses those profits are then passed through it's a pass-through entity passed through to you and you actually pay your taxes on those profits on your personal tax return at your personal tax rate so what's the difference between that and how your tax on a sole proprietor they sound almost the same at the end of the day let me explain the difference and which one is a better fit for you so should you run your business as a sole proprietor or should you form an LLC which one is the best one here is the back-of-the-envelope answer and then I'll unpack it easiest way to start on your business is as a sole proprietor and I would say forget even thinking about forming an LLC until you are making at least $50,000 or more in annual revenue here's why when you're just starting out as a business you're usually making little to no revenue right we'll have to start somewhere so the potential tax benefits of running your business through an LLC more on those in a moment don't outweigh the costs incurred by having an LLC things like having to file a separate tax return possibly paying a CPA or an accountant to handle all of that and do your bookkeeping as a sole proprietor you can do everything that an LLC can do you can set up a separate checking account for your business which you should be doing from day one by the way and you can do this at any bank of your choice you can set up a DBA or a doing business as where you can set up your bank account or accept checks or accept payment under your business name and not your personal name even though you're still a sole proprietor in the state of Florida this is called the fictitious name and it's the exact same thing and then filing your taxes at the end of the year is a breeze simply use something like turbotax.com or H&R block or whatever software you like and most of them are online these days to fill out your normal 1040 and follow the prompts when they ask if you've made any extra or side income or if you have a business answer the questions about your revenue how much you made your expenses how much you spent and it will calculate everything for you how much you actually are taxed on and what that tax should be based off of how much your overall income level is and all of the deductions therein all you have to do is keep good records of your income and your expenses including probably receipts at least take a picture of them save them the Dropbox or Evernote or wherever you like that way in case you get an audit it's really easy to show what your expenses were that they were valid expenses so the question is when does it make sense to form an LLC well I personally started my first business the recording revolution as a sole proprietor and I ran it that way for over three years I had a fictitious name or a DBA the Recording Revolution was able to accept payment for years and years into my business checking account under that name but I filed my taxes as a sole proprietor and it worked great so why the switch two reasons one I was making a lot of money and I was afraid that my tax returns look like a giant red flag for a potential audit and two I was curious to know what kind of tax savings I might realize if I formed an LLC tax savings two of my favorite word's and all the English language let's talk about the tax benefits of running your business through an LLC how that all works and when it makes sense to form well the big difference with an LLC is that you no longer have one role you now where to hats legally you are both owner of the LLC and an employee in or for the LLC you own it and you work for it that's right if you set up an LLC and specifically if you choose an S election to be an S corp on the federal level which I would recommend you do the IRS views you as two people and that's significant for this reason with an LLC this means you now must take a paycheck or a w-2 wage like any employer you would but you're also eligible to take the rest of your profits directly as what we call a distribution to shareholder kind of like a bonus and that makes sense because you are the only shareholder of your business you own all the shares and you are distributing profits to you the only shareholder make sense now why does any of this matter and what's the benefit at the point of it all great question pay attention whatever profit you take as a distribution shareholder is not liable for that spica or that Social Security and Medicare tax meaning you can save that 15.3% of self-employment tax that you were paying as a sole proprietor and you still have to pay federal income tax or state income tax Abed applies to you on all of your profits but not the additional 15.3% you must however pay that 15.3% FICA on any of your w-2 wages or your paycheck wages as an employee of your company and you must by law take a reasonable salary yes that is the language reasonable salary for the work you're doing meaning you can't be earning $10,000 a month and just pay yourself a hundred bucks a month okay let's just use a real example of real numbers so you see where the potential tax savings are let's say you're a sole proprietor and you're making $70,000 in profit per year from your business so let's say realistically you brought in eighty thousand dollars in revenue but you had ten thousand dollars of expenses that year so your net taxable profit according to the IRS is just seventy thousand dollars so let's assume that your jointly you're married at that income level $70,000 at least in 2018 you would be in the 12 percent tax bracket meaning you would owe 8400 dollars in federal tax now you got to add to that the 15.3% self-employment tax and your total tax bill is 19,000 110 dollars ignoring all other deductions and life circumstances now let's say you made the same amount of money but as an LLC with an S corp election okay you make the same $70,000 in profit but this time you only pay yourself a salary of $35,000 and you take the remaining profit of $35,000 as a distribution to shareholder so your w-2 wages or your paycheck would be taxed at your twelve percent federal income bracket plus the fifteen point three percent for FICA giving you a total of 27 point three percent or nine thousand five hundred fifty-five dollars while your remaining 35 thousand dollars of profit is only taxed at the federal rate of 12 percent for four thousand two hundred bringing your total tax outlay to 13 thousand seven hundred fifty-five now I'm ignoring state income tax for these examples that brings you a tax savings of five thousand three hundred fifty-five dollars just by earning the same amount of money as an LLC and not as a sole proprietor now of course you have to still factor in the costs of having an LLC forming it in the first place and filing a separate tax return every year and potentially hiring a CPA if things get little more complicated but you can see that those tax savings far outweigh the costs and the hassle of setting up a separate entity like an LLC so there you have it that's the big reason why people form LLC's is generally because you can realize a tax savings if you're making too little of money worth trying to do the calculations or even having a consultation with a CPA or talking to your CPA if you have one and running the numbers to see what does that breakeven point where you're really not making any tax savings worth the effort for setting up an LLC having a separate LLC in the cost of the LLC but you can find that point where you know if you make more than this amount of money you're gonna start to realize a tax break and it would be worth it for you to switch like I said generally I would even think about forming an LLC unless you're making at least $50,000 a year but that's just a rule of thumb now if you're thinking about forming an LLC but you're like how do I do that where do I do that do I need an attorney for that no you don't you can do a lot of this stuff online yourself for example there's a great company called Legal Zoom where you can form an LLC right from the comfort of your home in your PJs and they handle all of it for you for a nominal fee it's very simple you just answer the questions and they fill out all the forms for you and handle all the legal aspects of it I formed LLC's this way before it works great I've also used Legal Zoom for a bunch of other things like forming a will is setting up trademarks so they're a great company with great customer service so I can personally recommend them but there's a lot of ways to set up an LLC and you don't need to use on these companies to do it I hope that's helpful to you want to ask you a question leave a comment let me know two things one if you have a business or you're about to start a business are you a sole proprietor or are you an LLC and why is it been a good fit for you where you're at what other questions do you have about LLC's versus sole proprietors let's start a discussion below I'll see if I can help answer your questions thanks for watching thanks for subscribing to these videos see you on another video [Music]

Channel: Graham Cochrane

Views: 373,739

Keywords: llc, sole proprietor, llc vs sole proprietor, llc or sole proprietor, sole proprietorship, llc tax advantages, s-corp, tax advantages of an llc, should I form an LLC, should I stay a sole proprietor, what is a sole proprietor, what is an llc, how do I form an LLC, legal zoom, turbo tax, h&r block, graham cochrane

Id: pMoHLb3U6Sw

Length: 14min 56sec (896 seconds)

Published: Tue Aug 21 2018