How Does The Legal Structure Of Your Business Affect Tax Filing?

How does the legal structure of your business affect tax filing?

Deciding to flex your entrepreneurial muscles and start your own law firm is an exciting step in your legal career. Running your own firm means that you’re doing a lot more than practicing law. You’re also running a business. You’ll have to make big decisions about things like your location, your brand, your area of focus, and of course, how you plan to legally structure your practice for tax filing purposes. In order to help you make the right decision for your small or solo law firm, let’s explore some of your choices.

Sole Proprietorship

A sole proprietorship is a popular choice for many solo law firms. In this business structure, you’re the sole owner and operator of your practice. This also means you’re the one liable for your business’ obligations, such as any debts or losses incurred while you’re in business. You’ll be required to obtain the appropriate licenses and permits, but you won’t have to file any forms with the state. The income from your sole proprietorship will be reported on your personal income tax return.

Advantages of a sole proprietorship include:

  • Low tax rates
  • Inexpensive and easy to get up and running
  • Taxes are simplified
  • You’re in control

Disadvantages of a sole proprietorship include:

  • You’re personally responsible for any legal trouble you might encounter
  • You pay self-employment taxes
  • Raising capital can be difficult

Partnership

If you’re hoping to start a firm with another lawyer or business associate, then a partnership might be the right path for you. A partnership has two or more people who split the business responsibilities. In this structure, partners basically share everything equally, including profits, liability, and management. Partnerships file tax returns on the income of their business, and they also file taxes personally on their portion of the income or any losses. If you’re not too keen on sharing liability, you can see if a limited liability partnership is available in your state.

Advantages of a partnership include:

  • Inexpensive and easy to get up and running
  • Room for growth
  • Incentives for incoming employees to reach partnership level

Disadvantages of a partnership include:

  • Personally liable for the acts of others
  • Lack of control over business decisions
  • Potential for conflicts between partners

Limited Liability Company (LLC)

A limited liability company (LLC) is often seen as a blend of a corporation, a partnership, and a sole proprietorship. That means that you can still structure your business as an LLC if you’re running a solo law firm. Structuring your law firm as an LLC protects you personally from any losses or wrongful acts made by the company. The LLC itself doesn’t pay taxes — the owners of the LLC claim profits and losses on their personal taxes. LLC’s must file organization papers with the state and create an agreement on how the business will operate as well as the rights and responsibilities of the members and managers.

Advantages of a limited liability company include:

  • Members and managers have more protection
  • Any surplus earnings are not taxed
  • Not many restrictions on profit sharing

Disadvantages of a limited liability company include:

  • If a member decides to leave, the LLC is at risk of dissolving in some states
  • May be subject to self-employment tax
  • Some states put restrictions on certain professions operating as an LLC

Corporations

Corporations are single legal entities with limited liability and are typically owned by a group of people. A corporation has to deal with more red tape and formalities than other business structures. For instance, all paperwork must be filed with the state and you must create bylaws that will dictate the way a corporation will operate. You also have to create a board, have board meetings, and issue funds to the corporation’s stock. Corporations can be filed as a C Corp, which are separate legal entities owned by shareholders. They can also be filed as an S Corp, which allows profits and losses to be passed through personal tax returns and requires shareholders to pay taxes on distributed dividends.

Advantages of corporations include:

  • No personal liability
  • Easy to raise funds
  • Tax-deductions

Disadvantages of corporations include:

  • Lack of control, since the corporation is run by a board
  • Double-taxation
  • Complicated to get up and running

Now that you know a little bit more about the different legal structures of businesses, which one is right for you?

For more information about how to structure your new small or solo law firm, contact the tax pros at JETRO today!

For more details on this along with additional training and tax strategies to ensure you are paying the least amount in taxes as legally possible, check out our Tax Minimization Program!

If you don’t have an accounting or tax advisor (or you need assistance with anything discussed), click here to book your complimentary strategy session with JETRO.

How Do I Avoid A Big Tax Bill Or Surprise?

How Do I Avoid A Big Tax Bill Or Surprise?

I get it, everyone hates talking or thinking about taxes. However, avoiding the word tax only makes the situation worse. We hear stories from business owners all the time where they are simply paying too much in tax or are surprised with a big tax bill at year-end.

In our Free Facebook Group a member actually just posted about this so here we go.

How Do I Avoid A Big Tax Bill?

Plan, Plan, Plan

  • #1 Mistake Business Owners Make: Failing to Tax Plan
    • When thinking about tax, most business owners think about tax filing in March and April.
    • However, that is the LAST step in the process.
    • Tax planning should occur way before the year is even over.
  • What Is Tax Planning?
    • The act of doing research and implementing strategies to ensure you are paying the least amount in taxes as legally possible.
    • Check out Baseline Tax Strategies vs Advanced Tax Strategies for more information on type of tax planning strategies.
    • Most tax planning needs to be implemented BEFORE year-end.
    • We recommend sitting down in June to do tax planning. Why June? You have a half of years worth of data to see how your business is performing this year and you have a half of year left to implement those strategies.
  • Simply Put: If you are not doing any tax planning you are paying more in taxes than you should be.
  • My Goal: When you hear taxes you think of tax planning FIRST and tax preparation and filing AFTER that.
  • If you already got hit with a big tax bill, I understand it, that sucks. However, use that as your motivation to make a change NOW to avoid that in the future.

How Do I Avoid A Tax Surprise?

Estimates, Estimates, Estimate

  • Tax surprises are never fun, avoiding them involves multiple parts.
    • #1 – Accurate and Up To Date Bookkeeping: You need to have accurate and up to date bookkeeping so that you know how your business is performing at any point throughout the year. As part of our Tax Minimization Program we have an entire set of modules specifically on how to do bookkeeping on your own. Do NOT neglect this part of your business.
    • #2 – Tax Planning: We discussed this part above.
    • #3 – Estimated Tax Calculation: Once you have a good idea on all of your income (this includes business and non-business activity) you can do tax estimates. This entails taking the information/expected income and estimating what your tax bill will be so that you can properly plan and pay those estimated taxes as necessary.
  • #2 and #3 above often times play together. You may be estimating a large tax bill and thinking, how can I reduce that and that is when you will dive into additional tax planning strategies.

That is it! It all stems around planning. Make this be the year that you pay the least amount in taxes as legally possible and avoid any tax surprises.

For more details on this along with additional training and tax strategies to ensure you are paying the least amount in taxes as legally possible, check out our Tax Minimization Program!

If you don’t have an accounting or tax advisor (or you need assistance with anything discussed), click here to book your complimentary strategy session with JETRO.

How Are Start-Up Costs Handled?

How Are Start-Up Costs Handled?

Thinking of starting a business? Congratulations! This is one big step in tax savings. Being a business owner provides you a lot of opportunities for tax deductions that are not available to a typical W2 employee.

We talk about those tax savings options in most of our articles but today we are going to talk specifically about the costs associated with starting up your business and how those are handled.

We got this question a lot in our Free Facebook Group so I figured it was time to tackle it to clear things up for everyone!

What Are Start Up Costs?

Instead of waiting until you officially open for business, you can start the timer now on your deductible expenses. 

  • Per the IRS website, start-up costs are amounts paid or incurred for:
    • Creating an active trade or business
    • Investigating the creation or acquisition of an active trade or business.
  • To qualify as a start-up expense it must meet both of the following tests:
    • It is a cost you could deduct if you paid or incurred it to operate an existing active trade or business (in the same field as the one you entered into).
    • It is a cost you pay or incur before the day your active trade or business begins.
  • Here are some common start-up expenses we see:
    • Travel Costs 
    • Meal Expenses 
    • Training Costs
    • Market Analysis
    • Book or magazine purchases related to the business.
    • Office supplies to use in the business.
    • Advertising fees for the opening of your business.
    • Wages or contractor labor for consultants and employees.
    • etc.
  • Costs That DO NOT Qualify As Start-Up Expenses
    • Interest
    • Taxes
    • Research and Development Costs
    • However these can generally be deducted under other tax law provision.

What Are Organizational Costs?

Wait, organization costs? That’s not considered start-up?

  • The IRS has two separate categories for what you might think of as start-up costs. We discussed actual start-up costs above. 
  • Organizational costs are those expenses for the actual formation of the company. This would be if you are setting up an actual entity and not just a sole prop.
  • Examples of organizational costs are:
    • State incorporation or registration fees
    • Legal and Accounting Fees
    • The cost of temporary directors
    • The cost of organizational meetings
  • To summarize, you may have both start-up costs AND organizational costs.

How Does The Tax Deduction For Start-Up and Organizational Costs Work?

Alright, so now that we understand what are start-up and organizational costs, how does the deduction work?

  • Important Number: $50,000 (For Each Start-Up and Organizational Costs)
  • Total Less Than $50k
    • Deduct $5,000 in the first year the business starts
    • Amortize Remaining
  • Total More Than $50k
    • First year deduction decreases by $1 for every dollar over $50k
    • Amortize Remaining
  • How Amortization Works
    • Deduct Remaining Equally Over 180 Months (15 Years)
    • Complete and attach Form 4562 to your return for the first year in business.

Examples Of Start-Up Costs Deduction

Lets put this into practice and use some actual numbers..

  • Start-Up Costs: $3,500
    • Deduct all in first year of business
  • Start-Up Costs: $45,000
    • Deduct $5,000 in first year of business
    • Amortize remaining $40,000 equally over 180 months ($222 per Month)
  • Start-Up Costs: $52,000
    • Deduction $3,000 in first year of business ($5,000 less $2,000 over $50k)
    • Amortize remaining $49,000 equally over 180 months ($272 per Month)
  • Start-Up Costs: $65,000
    • Amortize all $65,000 equally over 180 months ($361 per Month)
  • Organizational costs would work the exact same way, if you qualify.

Start-Up Costs Frequently Asked Questions

I still have questions..

  • When are you considered “in business” and no longer start-up costs?
    • When a “sale” occurs. Lets use an example of starting a lawn service. You may have made flyers and bought some weed killer and a few garden tools these would all be start-up costs until you have your first sale. Once you first sale occurs expenses are just normal operating costs.
  • How does equipment factor into this?
    • Equipment would not be included in start-up costs but rather depreciated. Lets assume you are starting that lawn care business. Your new lawn mower for the business would be an asset that you depreciate and not included in start-up costs. 
  • When can I start recording these start-up costs?
    • You have to wait until the new business actually begins to start realizing the tax benefits of your start-up expenses but you can start accruing and recording them as soon as you start thinking about creating your business.
  • What happens if my start-up never becomes an active business?
    • You need to start and make the business an active business for the start-up costs to be deductible. If you fail after starting, then you can realize the unamortized deductions. If you never start, the costs you had in your attempt to acquire or begin a specific business are capital expenses and you can deduct them as a capital loss. Costs you had before making a decision to acquire or begin a specific business would be personal and non deductible.
    • Keep in mind the specific piece. Example, if you are just doing general research/analysis and do not have any specific business in mind and you end up not moving forward with anything, those are considered personal expenses and not deductible.
  • What else should I keep in mind?
    • Always keep detailed and accurate records to substantiate your costs in case the IRS challenges you.
    • Once your business starts, expenses after that start date move to normal operating expenses and stops the addition to start-up costs.
    • If you close your business before costs are fully amortized (180 months) you will take the remaining when closing.

This can often times be a confusing area but hopefully we were able to break it down in an easier to understand format for you.

For more details on this along with additional training and tax strategies to ensure you are paying the least amount in taxes as legally possible, check out our Tax Minimization Program!

If you don’t have an accounting or tax advisor (or you need assistance with anything discussed), click here to book your complimentary strategy session with JETRO.