The 3 Things You DON’T Want To Do When Forming Your LLC

Over the years I've seen a LOT of mistakes small business owners make when forming a Limited Liability Company ( LLC).  Some of these are made when entrepreneurs and investors form the LLC on their own, without the help of a professional.

But you know what's really irksome?  Some of these mistakes — in fact, most of these mistakes — are made by attorneys and accountants.  Professionals who should know better.

3 dumb mistakes

Here are the three mistakes that I see people make again, and again, and again.

Mistake #1: Electing to be Treated as a C Corporation
An LLC is a disregarded entity for tax purposes. This means that an LLC with a single owner will be treated as a sole proprietorship unless it makes an election otherwise.  That election is to be taxed as a C corporation or an S Corporation (assuming eligibility requirements are met.) An LLC with multiple owners can be treated as a partnership, a C corporation or an S Corporation (again, assuming eligibility requirements are met.)

But just because you can do something doesn't mean you should.  And unless you've received expert advice from your tax strategist, you shouldn't make the election to be treated as a C corporation.

A C Corporation is taxed on its profits. When those profits are distributed to shareholders (you, the owner), the profits are taxed again as dividends.   By electing to be taxed as a C Corporation, then, the LLC owners create an extra level of taxation.

Not something you want to do, right?

Mistake #2: Ignoring Foreign LLC Registration Rules
We've all read those tempting ads for Delaware or Nevada limited liability companies. Sound pretty good, don't they?  DON'T DO IT!! At least not until you've run the idea past your tax strategist.

Here's why:

If you're doing business in, let's say, Georgia, you're not going to be able to avoid state taxes by forming your LLC in Nevada or Delaware. The tax and corporation laws in your state will require you to register your out-of- state, or foreign, LLC in the states where your business operates. This means added cost since you will pay annual registration fees to both states.  Those same laws will require you to pay state income taxes in the states where you earn your income.

NOT good.

Mistake #3: Making an S Corporation Election Too Early
I am a BIG fan of electing S Corporation status for your LLC if the income generated by your business is considered “earned income.”  If this income was taxed as a sole proprietor or partnership it would be subject to self-employment tax.  If an S Corporation election is made the self-employment tax is eliminated, saving sometimes thousands of dollars per year.  (Owner salaries would, however, be subject to employment taxes.)

That being said, you don't want to elect S Corporation status too early–especially if the LLC is owned and operated by a single owner.

By electing S Corporation status, the LLC needs to file a corporate return, needs to begin doing payroll–even if the only employee is the owner, and may need to pay additional payroll taxes.

Wait until your business is profitable to elect S status for your LLC. You patience will pay off in two ways: simpler accounting and less expensive tax returns.

Avoiding these all too frequent mistakes will save you both time and money.  If you have questions about forming your LLC, feel free to give me a yell.

Until next time, thanks for reading!  Your comments and questions are welcomed below.