Three Dumbest LLC Formation Mistakes
Below is a MRR and PLR article in category Finance -> subcategory Taxes.
Three Critical Mistakes to Avoid When Forming an LLC
Summary
Planning to start a business and considering a Limited Liability Company (LLC)? Avoid these common pitfalls highlighted by LLC expert and tax professor Stephen L. Nelson.Article Body
As someone who occasionally teaches a graduate tax class on LLC formation, I've seen plenty of mistakes. Most are made by entrepreneurs and investors trying to cut costs on accountant and attorney fees?"though this can be a classic case of being penny-wise and pound-foolish.What truly surprises me, however, is that many mistakes come from attorneys and paralegal services?"professionals who should really know better. Let’s dive into the three most frequent errors I've encountered:
Mistake #1: Ignoring Foreign LLC Registration Rules
Those enticing ads for forming an LLC in Delaware or Nevada might catch your eye, but they're often not ideal for small businesses. If your operations are, for example, in New York, setting up an LLC in Nevada won’t exempt you from state taxes. Your home state’s tax and corporation laws demand registering your out-of-state LLC in the states where your business actually operates. Additionally, you will need to pay state income taxes based on where your income is generated.
A few more points: Large corporations might benefit from Delaware due to its sophisticated court system, but this is relevant mainly for huge enterprises that litigate extensively there. Similarly, Nevada offers a tax haven for corporations, but it requires establishing a genuine business presence, including an office, employees, and property.
Mistake #2: Choosing C Corporation Taxation
An LLC is flexible for tax purposes. A single-owner LLC can choose to be taxed as a sole proprietorship, a C corporation, or an S corporation (if eligible). Multi-owner LLCs can opt for partnership, C corporation, or S corporation status.
However, just because you can opt for C corporation taxation doesn’t mean you should. Without expert tax consultation from an attorney or CPA, electing C corporation treatment can create an extra tax layer. A C corporation's profits are taxed, and when distributed to shareholders, taxed again. This double taxation isn’t ideal for most LLC owners.
Mistake #3: Electing S Corporation Status Prematurely
While LLCs can be treated as S corporations, timing is crucial. If your business isn’t yet generating significant profits, electing S corporation status can be costly?"especially for single-owner LLCs.
Choosing S corporation status means you must file a corporate tax return, run payroll even if you are the only employee, and potentially incur additional costs like the 6.2% federal unemployment tax on the first $7,000 of wages per employee.
Wait until your business becomes profitable before opting for S corporation status. This patience can lead to simpler accounting and less expensive tax returns.
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By understanding these common mistakes, you can make informed decisions when forming your LLC, ultimately saving time, effort, and money.
You can find the original non-AI version of this article here: Three Dumbest LLC Formation Mistakes.
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