So you’ve decided to take the leap and form a corporation or LLC to house your book or your back-end business. Having helped my clients form hundreds of corporations and LLCs–and being an author myself–I will attempt to demystify the process and make it less intimidating. This post will cover general steps that are required in many states, but first, let’s get the legal stuff out of the way…
**DISCLAIMER: I am not a CPA or an attorney and the topics discussed are examples used by past and current clients. No two situations are alike and techniques that work for one person may not work for another. No action should be taken in regards to any of the subject matter in the blog unless under the guidance of certified professionals such as CPAs, attorneys, and financial advisors.
CHOOSE A BUSINESS ENTITY
The question I get asked most often is do I need a C corporation, S corporation, or an LLC? All have advantages and drawbacks, and the answer will depend on several factors: what personal tax bracket you are in, whether you are married or single, whether you have a job in addition to operating a business, what kind of fringe benefits you wish to offer yourself, etc.
One thing I will tell you is to stay away from CPAs or other “experts” who tell you, “you should always form an LLC” or “you should always avoid a C corporation.” There is no “always” when it comes to business because we all have unique life situations that can affect how we get taxed, and one person’s situation may be best suited to an LLC while another may be best suited to an S corporation or C corporation.
The real answer is that it does not really matter which entity you choose to form, because if you find out along the way that you are missing out on some tax savings, you can easily move between the 3 entities. For example, a C corporation can switch to an S corporation and vice versa. LLCs can elect to be taxed as a C corporation and all this can be done with the filing of an IRS form. So don’t get caught up in analysis paralysis. Choose one that seems to work for you, or seek the advice of an expert that can really look at your situation and choose an entity that benefits YOU the most.
That said, here is some info on some of the basic tax differences between a C corporation, S corporation, and LLC:
C corporations – taxed a flat 21% at federal level, plus state corporate tax.
S corporations – taxed at personal level. Percentages increase as income increases..
LLC – taxed at personal level. Percentages increase as income increases.
So, you can see that the major difference is the flat tax of 21% versus the variable personal tax rate. Personal tax brackets in 2021 range from 10% to 37%, depending on how much money you make. You can see how an S corporation or LLC may be the right choice at the beginning when profits are lower as you are only taxed at 10% for the first $10,000 you make, approximately. Once your income reaches about $40,000, the tax rate jumps to 22%.
Since a C corporation is only taxed at a flat 21%, you may want to switch to this entity type once your business income reaches a certain level. This way you can enjoy increased profits while maintaining the same tax rate.
STEPS FOR SETTING UP A CORPORATION OR LLC
Keep in mind that the steps are virtually the same for either entity (corporation/LLC)
STEP #1 CHOOSING A NAME
Choose a good name for your company. Ideally, the name will not have your name or initials in it. This adds another layer of privacy and also makes your company look more professional. Entrepreneurs love to use their name or initials–my first company name was “MDW Enterprises, Inc.”– but it gives the impression that you are small time. I eventually changed the company name to the more general “Augmentus Business Solutions.” The name comes from a combination of the words “augment” and “us,” which felt appropriate given the assistance I was providing clients in the growth of their businesses.
Come up with several variations on the name you create in case it has already been taken.
Go to the Secretary of State database and perform a search to see if the name has already been taken. Some states are pickier than others and may reject your filing if the name is too close to others. If you are forming a corporation, you will also need to check the LLC database as the filing can get rejected if the name is too close to that of an LLC and vice versa. Some states (such as California) require you to do a separate name search for both entity types while others include both in a single database.
For example, A-Plus Construction, Inc. may be denied if there is already an A-plus Construction, LLC. Sometimes you can get away with adding a variation on the name–“A-plus Construction Enterprises, Inc.”–if the representative at the Secretary of State’s office is in a good mood. If the name still gets rejected, try something like “A-plus Building, Inc.” or “A-Plus Builders, Inc.”
You’re going to be stuck with your business name for a long time, so make sure it’s something you can be proud of.
STEP #2 PREPARE AND FILE ARTICLES
The next step is to prepare the Articles of Incorporation for corporations (Articles of Organization for LLCs). The articles contain the entity name, business address, mailing address, registered agent, purpose statement, and the incorporator. LLCs require you to list the management structure: member managed, or manager managed.
Most states allow you to file the articles online at the Secretary of State website. Some states require you to mail in a hard copy to the Secretary of State’s office.
Filing fees are generally $100-$200. However, they can go much lower and higher depending upon your state, as low as $45 in Arkansas and up to $300 in Texas.
STEP #3 OBTAIN YOUR TAX ID FROM THE IRS
The IRS will issue your business an EIN (Employer Identification Number), otherwise known as your business Tax ID. It is a good idea to wait until your articles and business name have been approved by your state before you go get a Tax ID in the business name. You do not want to obtain a tax ID too early and find out that your business name has been rejected by the Secretary of State. You would have to go get another tax ID from the IRS and shut the other one down.
STEP #4 ORDER YOUR STOCK KIT (OR MEMBERSHIP KIT FOR LLCs)
These kits obtain stock certificates (membership certificates for LLCs) and stock ledgers that record to whom you issue stock. Be sure to issue yourself stock right away. If you get sued and you have not completed this step, the suing party may be able to pierce the corporate veil and come after your personal assets by claiming that you were not acting as a legitimate business.
Many kits run between $50 and $100 and come with templates for bylaws (membership agreements for LLCs) which outline the rules that you can choose to adopt for running your corporation. Be sure to also complete this important step as to maintain asset protection. Some of it is straightforward, and some of it may require you to seek the advice of an expert.
STEP #5 OPEN BANK ACCOUNTS
Most banks require your tax ID and your Articles of Incorporation to open a bank account for your business. Other banks may require other documents, so it is a good idea to call your bank for a list of required documents before heading down there, so you don’t have to make multiple trips.
STEP #6 FIND A REGISTERED AGENT
By law, every corporation or LLC must have a registered agent. A registered agent is a person or entity that is available for someone to serve a lawsuit during normal business hours. You can be your own registered agent if you have someone at your office during normal business hours Monday through Friday. However, if you are running your business from your house as a solopreneur and you are out meeting clients during the day, you can get into trouble by not being available for a lawsuit to be served. It is not always a good idea to have your home address listed on public record. Thus, you may want to hire a company to act as your registered agent. This adds a layer of privacy for your personal residence and ensures that someone will be available 100% of the time during business hours. Registered agents typically cost $75-$150 annually. My company offers registered agent services for our clients in CA for $100 and we include the annual filing of the statement of information (including the $25 state filing fee).
STEP #7 FILE ADDITIONAL DOCUMENTS ONCE FORMATION IS COMPLETE
In most states, you will have to file an annual document that lists your business’s physical address, mailing address, and registered agent. Many states have their own version of this form, which may require additional information.
This report typically keeps the state up-to-date on any changes in mailing addresses or corporate headquarters for your business entity, any new company directors and their addresses, and sometimes even earnings for the year as the price of the annual report can sometimes be based on revenue. These reports can range from as little as $0 all the way to $500 or more depending on the state of incorporation. Some states charge an annual fee in addition to the annual report fee. Nevada charges $500 for its annual fee (business license registration) and another $150 for the annual report of officers and directors.
These states charge $0 for their annual filings: Arizona, Idaho, Minnesota, Mississippi, Missouri, New Mexico, Ohio, South Carolina, and Texas.
Colorado, Hawaii, Kentucky, Montana, Nebraska, New York, and Utah charge $20 or less for their annual report filings.
FILE ANNUAL TAX RETURNS
Remember that you will have to file a separate tax return for your business in most cases: IRS Form 1120 for corporations, IRS form 1120-S for S corporations, and IRS form 1065 for LLCs with multiple members. Don’t forget to also file a state tax return if your state requires it (most states do).
You will have to pay a CPA to file taxes for your business entity which can typically cost between $250 and $500 each year for a simpler tax filing. CPAs can charge up to $1000 and beyond for more complicated business filings, but that usually happens when you have several different types of income that are difficult to track–usually if you have this problem, you are making a lot more money and can afford the increased professional fee.
MAINTAIN YOUR CORPORATION
Be sure to keep up on your annual fees, annual document filings, and tax returns. A state may revoke your corporation or LLC if you do not. Most entities require some sort of annual meeting. Corporations require annual meetings to elect officers and directors and even meetings for major decisions or corporate actions such as purchasing equipment or vehicles, signing leases, adopting employee benefits packages, etc. If you get sued and you have not completed this step, the suing party may be able to pierce the corporate veil and come after your personal assets by claiming that you were not acting as a legitimate business.
CAN I CREATE A CORPORATION OR LLC IN A DIFFERENT STATE?
The short answer is yes. However, if you live in one state and file in another to avoid paying taxes in your home state, you will most likely lose that battle. I had a client in California that decided to file a corporation in Texas since Texas has a lower corporate tax rate at only 1%. He was attempting to avoid the California corporate tax, which is one of the highest in the country at 8.84%.
I warned him against this course of action since California’s Franchise Tax Board has been referred to as being even more aggressive than the IRS. They were able to locate my client’s corporation in Texas and they contacted him with the happy news that all the income the corporation had generated would also be taxed in California since he lived in California and owned 100% of the shares. My client now had to pay taxes and annual maintenance fees in both states, costing him a lot of money.
CONSULTING AN EXPERT IS ALWAYS AN OPTION
As an authorpreneur, you wear many hats. While you can choose to figure the process out yourself, you don’t have to go through the process of setting up a corporation or an LLC alone. You can hire someone to help you with each part of the process. My company provides a consultation in which we look at your individual situation and go over options with you. The fee we charge can be credited toward forming your corporation or LLC if you choose to use us for your services. We make the process super easy, which means you can get back to writing and publishing that bestseller.