Mid-Year Tax Planning: Do You Need to Add an Entity?

Do you need to add an entity to your tax structure?

This is such an important question for mid-year planning because knowing the right time to add an entity to your tax strategy can often save as much as $10,000 per year in taxes!

What entity should you consider adding to your tax structure?

Many of you want to know what entity you should consider adding to your tax structure. There are 2 levels of tax planning to consider in answering this question.

** Level #1 **

This level is for those business owners or investors who are either just starting their business or investment or are in the "ramp-up" phase of their business or investment. The ramp-up phase may mean you are a few months in to your new business or investment, or perhaps even a few years depending on the type of business or investment. The ramp-up phase means your business or investment has not yet produced a profit. Now, without profit, taxes are likely minimal or even non-existent, which is why the focus of this level is building a strong foundation for your tax structure so once there is profit, your tax structure is already in place to immediately minimize your taxes.

I often get asked the question "When should I form my entity for my business (or investment)?"

Many of the people I talk to are unsure if they should get their business up and going first, and then worry about the entity, or if they should have the entity in place even before starting the business or investment.

The answer to this depends somewhat on the type of business or investment, however, if I have to give an answer, I recommend setting up the entity first. This is because the right entity can grow and change with you as your business or investment grows and changes. Plus, outside of the tax benefits, many entities offer some level of asset protection which most people rank as an important planning factor.

So for those of you in Level #1, the entities to consider adding to your tax structure are:

Limited Liability Company (LLC). LLCs are the most flexible entity for tax purposes. LLCs can start off being taxed one way and then elect to be taxed differently. This means your LLC can adjust to the tax planning needs of your business or investment because your LLC can be taxed as a sole proprietorship, partnership, S corporation or C corporation. This flexibility is key in building a strong foundation for your tax structure and to minimize future taxes. S Corporation or Partnership. If your LLC will be formed in a state that assesses a separate tax on LLCs, then you should consider adding an S corporation or partnership instead of an LLC.

** Level #2 **

Level #2 is for those who already have a strong foundation in place for their tax strategy, and whose business or investment will soon be exiting the ramp-up phase or has already exited the ramp-up phase and is producing income. At Level #2, the focus is minimizing the tax liability created by your business or investment.

Consider a C Corporation if you are in the Level 2 planning group

One way to eliminate - not just reduce taxes - is to shift income to a taxpayer in a lower tax bracket. A C Corporation has initial tax brackets of 15% and 25%. If you are in an individual tax bracket of 25% or higher, then there could be an opportunity to reduce your taxes by shifting some of your income to a C Corporation.

For example, if you are in a 35% tax bracket individually and are able to shift $50,000 of income to a C Corporation, then your income tax is reduced by $10,000! And this can be an annual savings of $10,000!

BUT...

I know from experience that any time I suggest a C Corporation in a tax strategy, people panic! They think of all the bad things they've heard about C Corporations:

But what about the double tax?

But what about the personal service corporation tax?

But what about getting money out?

But what about the accumulated earnings tax?

What most people don't know (including many CPAs) is how to legally avoid these tax traps...BUT I do! In fact, some of them are not even tax traps at all - I have found ways to use some of these so-called traps to save taxes!