Liability Insurance

[alyssamma]

Wendy, wow, a lot of info here

OK, let's start with the parent/child company issue. My point is that *in general* when you try to set up companies or corporations to hide things, the courts end up not allowing it. For example, if you form company A to employ yourself and give yourself nice retirement benefits and then form company B to hire your employees and give them zero, you are in violation of ERISA laws.

Or, say you want to hire someone to service your vending machines and decide to call him a contractor so as to not pay FICA taxes. Well, you are in big trouble there.

The point I am trying to make is that simply because it *looks* like you can do something according to the law, most likely you can't if it involves trying to hide something or get out of paying something.

Corporate law is unbelievably complex. For example, close to 10yrs ago a bunch of contractors sued Microsoft. They said that even though they were contractors, they were "treated" like employees and therefore are owed benefits. I am in this industry and the results of that lawsuit impacted me directly.

Things like this sound silly, and a "normal" person would ask how this could be. But then you get the lawyers involved...

So, this is my point about the parent/child companies. A good lawyer would sue both companies. Especially if the larger company has the deep pockets.

And understand that win or lose, defending yourself against a lawsuit will break you. It will be a Phyrric victory if you do win.

My advice on this board has consistently been this: if you have few assets, an LLC is fine. If you have significant assets get an LLC + good insurance. Or, simply good insurance.

Now, on to the accountant. Don't take this the wrong way, but I think you need a better accountant

First, an LLC offers liability protection. That is what the second L is for. This is a legal issue and not an accounting issue.

Second, an LLC can be taxed in one of 4 ways - like a sole prop (you simply file a Sched C and can only have 1 member), as a partnership (you file a 1065 and must have 2 or more members), like an S-Corp or like a C-Corp.

To be honest, there are reasons to pick the S-Corp and C-Corp, but they are beyond my understanding of accounting. I would advise simply forming an S- or C-Corp and not go through the hassle of the LLC.

For this discussion I am going to compare LLCs and S-Corps. It is the same for our purposes as an LLC as a sole-prop or partnership vs. LLC as an S-Corp.

Anyway, with an LLC you take a "draw". With an S-Corp you take a "distribution". (I'm not going to talk about C-corps as people don't form them to get around the FICA taxes.).

There are several differences between these two. First, for a draw (LLC) you take that in the current tax year. For a distribution (S-Corp), you take that in the following tax year (i.e., against profits from the previous tax year).

(Note that both S-Corps and LLCs are passthru entities. Basically this means draws/distributions have zero effect on the personal taxes you pay).

For an S-Corp, distributions are not subject to FICA taxes - as long as you pay yourself a reasonable salary. And, of course, that's the rub. You can't make $10K on vending and say you will pay yourself $5K and take the rest as a $5K distribution. A $5K salary is not reasonable (unless you have a really good tax lawyer).

And note the IRS is cracking down on S-Corps taking large distributions. FICA taxes are the one thing that drives the IRS crazy. It is one of the few things that the IRS can come after *you* personally for and ignore the "corporate shield". Screw up here and it doesn't matter how many company/corp layers you have - the IRS is coming to your door for your assets.

This is why I've told people they need to make $40-$50K before forming an S-Corp (or taxing an LLC as an S-Corp) becomes worth it.

Why? Well, first it really isn't a 15% savings for an LLC. It is a 7.65% savings for an LLC because you deduct 1/2 of Self Employement taxes. (It is, however, a 15% savings for an S-Corp). Second you'll have to pay yourself probably $30K or so before you can safely start to take distributions (some may be more aggressive and do this earlier...). So, I figure you need enough extra income on top of that $30K to make the extra filing requirements of an S-Corp worthwhile, hence my $40-$50K figure.

Note, however, there are ways to do this exact same thing with an LLC not taxed as an S-Corp. But this won't apply to most people here as you need to be a passive member in the LLC.

OK, all of that being said. Let's clear up one more thing. With an LLC you can absolutely take a salary. It is uncommon for managing members (happens all the time for emps), but there are no rules to prevent you from doing this.

Lastly, a few more comments...

With QuickBooks, payroll is extremely simple to do yourself.

The best self-retirement plan around is a SEP-IRA. However, you must pay yourself a salary for this (further complicates the salary vs. distribution to save FICA taxes issue).

Lastly, I think this is the longest post I've ever made here and undoubtedly the most complex. Excuse me if it isn't 100% clear and feel free to ask for clarification

Kevin

[alyssamma]

Kelly, thanks

[jaharra]

So Kevin, 

Thank you for expounding on this complex, head-spinning material. :?   As you have probably noticed, I can be quite inquisitive so if I begin to wear on you please let me know.  Remind me what you do and how are you such a wealth of knowledge on this subject?   Thank you too for your offer to clarify some of the things you mentioned, I'll take you up on that!  Here goes....

When you mentioned "For example, if you form company A to employ yourself and give yourself nice retirement benefits and then form company B to hire your employees and give them zero, you are in violation of ERISA laws*" If the people hired were actually "contractors" under this scenario, would it be legal then and not in violation?

I.e., regarding hiring someone to service my vending machines, if I follow the laws for contractors to not tell them "how" to do the job, nor have a set schedule, etc. would I need to be worried about being in trouble in hiring them that way?

(I've been hired that way a few times myself.)  Also, in researching paying unemployment taxes on emps. in my state, for any employee who makes an unemployment claim, I would be required to repay the ENTIRE amount of their benefits in FULL through increased premiums. (For that reason, I don't think I could afford consider hiring anyone under an "employee" status because a couple of times of that and one would be out of business unless they were highly profitable.)  It seems to me like it would be doable to give "contractors" the objective of quality and timely servicing, etc., and let them run the route the way they want to. 

Thanks for the advice on the accountant. I haven't chosen any yet, I'm just gathering info. which helps steer my future planning.  Interestingly, of the two that I called and spoke to about my business plan, they both gave me the same advice.

I'm inclined to think that a C-corp would be less beneficial over other entities due to advice I've heard of having to pay both corporate and personal taxes, and the C-corp. can be legally liable for it's actions. I've also heard mention that C-corps are more often used when earning over 6 figures.

In mention of the difs. between the LLC (that takes "draws") and S-corps (that take a "distributions"), if one was the LLC/S-Corp. hybrid so to speak, would they be able to take both?

Regarding the LLC/S-Sorp hybrid again perhaps you could clarify how it wouldn't have the 15% tax savings like the S-corp alone?  My understanding is an LLC isn't recognized by the IRS and is taxed by the election, like an S-corp. or Sole Prop. etc.

You touched on this earlier Kevin that got me curious, do you mind sharing with us how a non-S-Corp. LLC can have the 15% tax savings as a passive member in the LLC?

Ok, for the S-corp. if you make $10k on vending and 1/3rd of that goes to overhead, leaving $6k or so, what is the remaining amount called? Would all or just some of that be salary?

Or with what the accountant I mentioned said about "if I don't make enough for a salary, it's not reasonable to take a salary", what would the funds after expenses be called? Would it be income? Which is subject to self-employment tax or not?  Just to clarify, it sounds like "distributions" are the only thing that isn't subject to the 15% self-employment tax?

How does an S-corp. determine what is a reasonable "distribution" and what are they supposed to do with anything extra? Are they supposed to increase their salary? (I beleive I read that the salary should match what is reasonable in the industry. I looked that up on my state employment website and I think it ranged in the $10-$18/hr. range for vending servicing.  Management would add more to that, but I don't think a lot.  There wasn't data for "owners".)

Would an LLC/Sole-P. still offer the protection of an LLC that a Sole-P. by itself doesn't offer?

Thanks a bunch Kevin and feel free to take a break from this to enjoy the holiday if you wish! :dude:

[alyssamma]

OK, settle in for another long post

First, my current business is consulting (computers). In my previous life I was an engineer and taught High School math and physics. I’ve started 3 businesses over the years – a C-Corp, S-Corp and an LLC (only the last two are still active now). I worked with a lot of accountants on past projects and just picked up some things. All of that being said, I’m not an accountant so it is best to always double check anything I say  Luckily Google is very easy for doing that, or your favorite accountant.

Classifying “workers†as contractors or employees is a very sticky situation and the IRS can be funny about it. The problem is that if you call someone a contractor you don’t pay FICA taxes for them. As mentioned before, this is something the IRS will come after you personally for – they are very touchy about it. If the workers have their own company/corporation, then it is very clear – no worries there – they can be contractors. But if they don’t, then you have to be careful. I always err on the side of caution, so my advice would be if they are short term, or do something totally unrelated to your business (e.g., you own a vending business and hire them to do payroll), then you are fine. Otherwise, treat them as employees.

As for unemployment premiums, I am not familiar with Utah laws, but that is very unusual what you said. I did some searching and could not find anything related to that. This would negate the entire concept of unemployment insurance. Can you tell me where you found that out? Unemployment premiums are usually very small (e.g., for my wife and myself we pay about $260 total for both of us for federal and state for the year).

As for your accountant…I don’t want to get into an argument there, but let me give some examples of why I think he might not be 100% correct. In your example of using the 15% savings to fund a retirement account, I would take exception with this. For a profitable small business I would say a SEP-IRA is the best retirement option out there. The way it works is this: the company puts 25% of your salary into a retirement fund. This money is tax deductible (to the company, which, since it is a passthru entity means tax deductible to you), but unlike the ROTH-IRA does not grow tax free. Still, the cap on it is very high (unlike, say the 401(k)) and there are no reporting requirements for it (again, unlike the 401(k) which is a PITA for reporting). The catch? It requires you pay yourself a salary since the contribution is 25% of your salary. If you only take distributions then you can’t put anything away. As you can guess, the math gets complicated – 15% less in payroll taxes vs. 25% less in income, which can be a 5-10% tax break depending on my income bracket, and puts lots of $ into my retirement account.

To further clarify this, your accountant’s client saved $15K in taxes in your example. A ROTH-IRA (the next best thing to a SEP-IRA) has a limit of $5K/yr. Where do you put the other money? What retirement vehicle? I would say pay yourself a salary and dump $ into a SEP-IRA.

So, if you really want to maximize your retirement money, it can get rather complicated. The best option would be a ROTH-IRA + SEP-IRA. I would definitely recommend an accountant for this, but one who doesn’t tell you about a SEP-IRA I would steer clear of.

The other “warning light†was the “take no salary†part. With S-Corps, the IRS is very sensitive to this. Again, this is because you are avoiding paying FICA taxes. It really all comes down to what you are comfortable with, and I already told you I am a little conservative. A good friend of mine who is an accountant always says it’s only illegal if you get audited

There is little legal difference between a C-Corp and S-Corp. In fact, all S-Corps start off as C-Corps and must file yearly for their S status. As with an LLC, all are “liable†for their actions. However, this is a good thing. This is exactly why you form these entities so that you are not liable.

A C-Corp can actually be the best entity to form depending on how much money you make. You are correct in that you need about 6 figures. This is because C-corps have a very low tax rate compared to personal tax rates.

However, it isn’t a negative that you pay personal and corp taxes with a C-Corp. You pay the same amount of taxes with an S-Corp and LLC too. Here is why: C-Corp makes $100K and you take a salary of $30K. You pay taxes on the $30K and C-Corp pays taxes on the $70K.

Now, an LLC makes $100K. You pay taxes on the $100K.

In both examples taxes were paid on $100K.

As for the LLC/S-Corp “hybridâ€â€¦don’t think of it this way  Understand that an LLC is an LLC and an S-Corp is an S-Corp. One is a company and the other is a corporation. However, the IRS has said that for tax purposes (and only for tax purposes) you can pay your LLC taxes like an S-Corp (or C-Corp) if you want.

If you choose to have your LLC taxed like an S-Corp and take distributions then you save 15.3% on the income taken as distributions. If you have an LLC and simply take draws (i.e., taxed as sole prop or partnership) then you save 7.65%. This is because of the 15.3% you pay in Self Employment taxes the IRS lets you deduct half. So, you only “save†7.65%. I realize in re-reading what I wrote this is confusing, so let me give an example:

S-Corp makes $100K and pays you a salary of $60K and you take $40K in distribution. You will pay FICA taxes of 15.3% on the $60K (or $9180) and nothing on the $40K.

LLC makes $100K and you take it all as a draw. You pay 15.3% FICA taxes, but deduct half, so pay $7650 in taxes.

In this example the LLC pays less taxes. Of course you could pay yourself a $40K salary from the S-Corp and pay less FICA taxes. But then if you had a SEP-IRA you would be putting less into your retirement

For the LLC, if you are a member (LLCs have members, corps have shareholders), and you do not participate in the management of the company (e.g., you invested $, but someone else runs the company), then the draws you take are not subject to FICA taxes. This is how you avoid the 15.3%.

Both S-Corps and LLCs are passthru entities. This means what’s “left over†at the end of the year gets reported on your personal 1040 (via a K-1 or Sched C) and counted towards your income. Income is the total $ you make in the year. Expense are what you pay. In general Income – Expenses is what passes through to you – but not exactly. Some expenses (e.g., travel, meals) are not 100% deductible. Things like charity don’t count (you get credit for them on your personal taxes) and some things are amortorized. It sounds complicated but it isn’t. TaxCut/Turbo Tax can pound it out for you very easily.

Note there are some examples (specifically with losses) where this can get rather complicated.

Regardless, that $ is what you personally get taxed on. Since you have paid taxes on it, you can take it from the company tax free. Well, not really because you already paid taxes on it

So, this should answer the “funds after expenses†question. Income is total money you make. Funds after expenses are called Profit. This is what you want to maximize  Assuming you consider a salary an expense, then for an S-Corp you pay no FICA taxes on Profit. For an LLC, you would pay 7.65%. Again, see the example above on why the LLC still might pay less in taxes.

NOTE – I am using “profit†in a very generic, non-accounting term. A real accountant would not call what passes through to you profit. Also, there are many definitions of profit depending on what you are talking about. For our purposes here, we can simply say Income – Expenses and understand we are talking “in generalâ€.

As for how an S-Corp determines a reasonable salary…hehe, that is a good question  If you make a lot of $ it doesn’t matter as FICA taxes have a cap. Otherwise it depends on how conservative you are. For me, I want to take a healthy salary to maximize the amount I can deposit into my SEP-IRA. Others may not care about that. If your “profit†is more than your salary at the end of the year, I think you are in trouble. But, an aggressive accountant might disagree.

As for protection, remember an LLC is an LLC regardless of how it is taxed. Only the IRS cares about how it is taxed. If you go into a court, they will only care it is an LLC.

Now, that being said, one big difference in protection between an LLC and S-Corp is this. You must treat your LLC as a separate entity. Meaning you must have a separate bank account, not mix bills, etc. Otherwise you run the risk of having your LLC liability declared “void†and you being personally responsible for things.

Don’t let this scare you though. Just do the right things and you are fine

Feel free to ask more

Kevin

[bruce]

It's just not worth whatever trouble that may come your way.  For a couple hundred dollars, it's one thing you don't have to worry about any more.  There are enough lawyers looking for work & I don't need the grief.

[ekwp123]

I just received a quote in FL. About $280 in annual premiums for $1,000,000 of coverage from Auto-Owners. I like to sleep well at night and for less than $24 a month that is a price I'm willing to pay. 

[bruce]

My insurance bill was $243.00

I thought it was a great deal for something I don't have to worry about any more.

[antoniocinisi]

My insurance bill was $243.00

I thought it was a great deal for something I don't have to worry about any more.

a small price for peace of mind

[T BIRD]

Geez......I wish my insurance cost me $250 a year. Its tough doing business here in NY sometimes.

[sbishop]

My bosses have paid the lawyer over $6k in fee to defend a workers comp suit that the could have settled for $4k, and we have not even gone to trial.

Insurance will get you in some locations.

[tooldini]

I have a mobile windshield repair biz and have insurance to cover me with that. I called State Farm and was told I would be covered for vending also. Although it was written windshield repair there is language in the contract to cover me for vending also. I have 1 million in coverage for like 400.00 a year. I guess if someone could prove they got sick from candy or choked or something I would have some help. I think no matter what you do or have or say there could be bad things that happen to you when someone whats them to happen.

[Jarola]

The few lawsuits I have first hand knowlege of, the magic number seems to be $15,000.  You may consider putting that $1,000/year into a money market and consider yourself  "self insured".

 I like that "self insured"