When the majority of businesses start out, it’s rare for them to select an entity structure that still makes sense for them several years down the line, and that’s okay; circumstances and finances change, after all. But what isn’t okay, is when business owners don’t realize that they should be changing their structure, or postpone it for some reason, leaving them open to any number of tax inefficiencies.
Reviewing your chosen existing entity structure with Coral Springs accountants is the best way to determine whether it’s still the most tax efficient option, but you should also be aware of the following information:
Why the structure of your business is so important
Three critical things are determined by your company’s legal entity:
- Exposure to personal liability
Could you be jeopardizing your personal savings?
- Tax treatment
Are you paying too much in self-employment and income tax?
- Potential for growth
Can you raise enough capital or bring partners onboard?
Knowing when you should change your entity structure
If you see any of the following signs, it could be time to make a change:
- Significant net profit growth – if you’re a single-member LLC or sole proprietor, you’ll pay 15.3% self-employment tax on all net profits. But when you start to earn $60,000 or more in annual net profit, consistently, you could save thousands of dollars by electing S-Corporation tax status instead.
- There is a substantial liability risk – clients who sue the business of a sole proprietor can chase after their home, bank accounts, and retirement savings. Forming a corporation or LLC could protect you from this should you start hiring more employees or signing bigger contracts.
- Investors are interested in funding your growth – C-Corporations tend to be preferred by angel investors and venture capitalists, and if you’re in need of institutional capital, it could well be advantageous to convert into a C-Corp from an LLC.
- You want to attract top talent – C-Corps give more opportunities for attractive stock options and equity compensation plans that could help you find and retain the right employees.
- Your tax circumstances have become more complex – if your existing tax situation is growing increasingly complicated, it might be time to consider a more appropriate structure.
What to avoid when changing entity structure
From waiting too long to convert to a different entity, to trying to do it without guidance from local tax experts, although converting structures may be a smart move for your business, it’s important to take great care when doing so.
Other things to avoid are failing to update everything, including bank accounts, EIN, vendor agreements, insurance policies, contracts and licenses. Don’t do this and you could find yourself facing legal complications, or gaps in liability coverage. You should also ensure that if electing for S-Corp treatment, you pay yourself a salary deemed reasonable before taking distributions. Lastly, by not converting at the start of a tax year, you’ll inevitably create short tax years, and add complexity that you and tax planning in Coral Springs, could well do without.
Whether your revenue has grown considerably, or there have been major changes to your risk profile, a structure that once served you well, could soon start to hold you and your business back. If you would like to know if your existing entity structure is still performing well for you, or if it could be time for a change, schedule a consultation with a local tax advisor at the earliest.