When you first start your home business, you may wonder how to setup your business correctly. Most entrepreneurs who work from home with 1 to 2 employees would register an LLC.
An LLC is not a separate entity like a corporation. Instead, the IRS calls it a “pass-through entity” where all the profits and losses of the LLC pass through to the owner(s).
An LLC protects you and your personal assets, including your car, home, and bank accounts from liability if you’re ever sued or go bankrupt. With an LLC, you get to choose how you’ll be taxed. Unlike a corporation, you aren’t required to have a board of directors or shareholders when you set up your business as an LLC.
Let’s break down the four steps to setup your LLC with the “small business” tax status to save money on taxes.
Step 1: Check Your Business Name
Before you setup your LLC, make sure your business name is not already taken. Click here to check your business name availability.
LLC stands for Limited Liability Company and it’s a type of business structure that lets you classify your business as a separate entity from you personally. This allows you to keep your personal assets separate from your business assets while protecting them from your business’ debts and liabilities, including potential lawsuits.
What Can I Do with an LLC?
You can open bank accounts, hire employees, and obtain licenses and permits under your LLC. And all it takes is an annual filing fee with the state to keep your business in good standing to maintain your business status.
Step 2: Register an LLC
- LLC as a sole proprietorship
- S Corporation Tax Status
Before you can fill out the form to create your LLC, you’ll need a registered agent. A registered agent simply accepts responsibility for receiving correspondence for your business, usually tax notices and reminders of upcoming business deadlines. You can become your own registered agent if you live in the same state and have a mailing address. You can also hire a company to receive correspondence on your company’s behalf like this one.
Once you determine your registered agent, you’ll use their name & address to fill out the form to setup your company. It looks similar to this one.
Step 3: Apply for an EIN
An employer identification number (EIN) is a nine-digit number assigned by the IRS. It’s used to identify businesses. You’ll use this EIN to open bank accounts under your business name, to open merchant accounts to process credit cards, and to receive affiliate income from different brands.
It takes less than 10 minutes to get an EIN, and you can click on the APPLY ONLINE NOW button here.
Step 4: Fill Out Form 2553 to Claim Small Business Tax Status
Once you have your EIN from step three, you can fill out form 2553 to claim your tax status “small business”. This will give you the s-corp status that allows you limited liability protection while saving taxes.
The key advantage of an S corp is that it offers tax benefits when it comes to excess profits, known as distributions. The S corp pays its employees a “reasonable” salary, which means it should be tied to industry norms, while also deducting payroll expenses like federal taxes and FICA. Then, any remaining profits from the company can be distributed to the owners as dividends, which are taxed at a lower rate than income.
Can you save money as an s-corp?
Let’s say you earn $80,000 in net profit, which is revenue minus expenses. You’ll pay a 15.3% self-employment tax, which is $12,240.
However, if you are set up as an s-corp, here’s how you save money. After you pay yourself a salary, whatever money is leftover you would pay yourself and call this a dividend.
Back to the example with s-corp status.
- $80,000 net profit
- $40,000 reasonable salary
- $40,000 leftover paid as dividend
- 15.3% x $40,000 salary
- $6,120 taxes.
So now you save over $6,000 in taxes just by setting up your structure this way with the s-corp tax status.