After one of the most rewarding careers serving your country, are you are you looking for a nice quiet retirement job? Do you like the idea of low responsibility? Do you like the idea of a steady paycheck that, while stable, has almost no hope of increasing, regardless of your hard work? Do you think that being an economic taker vice an economic producer is the best option for you? If you answered “No!” to each of the above questions, you might be considering opening your own business.
While many people usually have the stars in their eyes, when starting a business after retirement or exiting the military, there are many effects of opening your own business. Some are good and some are bad, but there is one thing that you cannot avoid when you start a business and that is the dreaded tax man/woman. The IRS, state and local tax agencies have thousands of agents, whose only job is to make sure that you are filing your taxes correctly and paying what they think you should be paying. To determine your compliance with tax laws, it all starts in one place: choice of an entity.
Over the series of my next blog posts, I will discuss the choice of entity. While there are many choices, for tax purposes, they really fall into one of three categories:
- Partnerships
- Sole Proprietorships
- Corporations
This is not to say that there are not subcategories in each. In partnerships for example, there are general partnerships, limited partnerships, limited liability partnerships, limited liability limited partnerships, publicly traded partnerships, etc. Each of these has their various tax consequences, but they all fall under the group of partnerships in general. Care needs to be exercised as to choice of entity, because it is like getting married, easy to get into and difficult to get out, and along the way your choice of a structure will lead the choices you have going forward.
The last paragraph brings me to another point, the information in these blogs are general in nature and only serve to inform the general public, not you specifically. Each of us has a unique tax situation and you should discuss what I have written here with your CPA, EA or attorney; however, if you are planning on starting a new business and you don’t have a CPA, EA or attorney, you will need to hire one when the IRS or the state/local taxing authority comes knocking, and it gets expensive at that point. I will also take a blog post to discuss why you want to hire one now, but until then, if you are thinking of starting a business, find a local CPA, EA or attorney and discuss if the information I give you fits your specific needs.
Finally, your choice of entity should not primarily be about taxes. Yes, you read that right; the CPA just said that taxes should NOT be the primary consideration to your choice of entity. This was codified into the law (§7701(o) for the legal beagles) and it basically states that “the transaction change in a meaningful way “(apart from Federal income tax effects) the taxpayer’s economic position”[1] and you must have “a substantial purpose (apart from Federal income tax effects) for entering into such transaction.”[2] In English: if you do something and the IRS thinks that the only reason that you did this is to avoid taxes, it could put you into danger for reclassification, meaning more taxes, penalties and interest. This does not mean that we don’t have long discussions about how to pay the least amount of tax, but the big question is, “what are you really trying to do?” Be prepared to answer this question as this will likely be the first place your CPA, EA or attorney will start.
Check out these related posts on the subject: