NEW JERSEY LLC FAQ

For NJ taxpayers thinking of starting a one-person business - here is a FAQ I developed for a one-person LLC in the state of New Jersey for the NJ SCORE organization a few years ago

1.   Is an LLC necessary for the limited amount of business I am doing?

While not necessary, it is a good idea for any sole proprietorship to register as a one-person LLC, as an added precaution.  It is easy, inexpensive, and adds an extra layer of liability protection “just in case”.

{I have advised in my book THE NEW SCHEDULE C NOTEBOOK – “Every sole proprietorship, whether a part-time sideline business or a full-time activity, should register with their state as an LLC – assuming state law allows and the costs are not prohibitive.” – rdf}

2.   What is the fee schedule for registering an LLC in NJ?

The filing fee for registering an LLC in NJ is $125.00.  It can be done online at – https://www.njportal.com/DOR/BusinessFormation/Home/Welcome

Here is the website of the fee schedule for LLC filings – http://www.state.nj.us/treasury/revenue/dcr/geninfo/fees_pd.shtml#llc_file    

3.   What is involved in the annual reporting for an LLC and what is the fee?

A one person LLC normally reports income and expenses the same as a “regular” sole proprietor - on Schedule C of the proprietor’s annual Form 1040.  There is no separate income tax filing, as is the case with a corporation.  The owner does not receive a salary, requiring additional payroll tax filings, but a “draw”.  All the tax deductions and benefits allowed to a “regular” sole proprietor – deduction of health insurance premiums, deduction for a “home office” (if there is a profit) and the ability to establish a self-employed retirement plan are deductible on the 1040 of the owner of a one-person LLC.  The only separate filing requirement is an “Annual Report” filed online with the State of NJ.  This filing includes an annual fee of $50.00 (tax deductible).

4.   Is Business Liability Insurance cheaper with or without an LLC?

The amount of a business’s liability insurance coverage should reflect the potential liability that the business could incur.  The cost of registering and maintaining an LLC is so small that excessive liability coverage would probably be more expensive.  The mere fact that a business is registered as an LLC does not replace the need for business liability insurance, just as incorporating a business does not.  Limited liability merely helps to protect the owner’s personal assets in the case of a lawsuit.  A business, regardless of how organized or registered, would need liability insurance if there is potential for liability.

5.   I already have a NJ Business Registration Certificate – where else should I register?

This should be all you need to do to register your business with the State of NJ.  If you do decide to register as an LLC you may need to file a corrected registration.

6.   In NJ, where should I register my business name on the federal, state, county, city level?

If "This Is My Business" is the name of the business (or, for example "This Is My Business, LLC) and it has been given an EIN by the IRS and is registered with the State of NJ (and you have a NJ BRC) there is no other required registration that I know of.  You would only need to register a “trade name” if you were using a different name (i.e. the business was organized as John Doe, LLC, but you want to operate as "This Is My Business").  As stated above, if registering an existing business as an LLC you may need to notify the IRS and/or State of NJ of the change.

7.   I haven’t received any forms from NJ to report quarterly losses – am I supposed to request them?

 As either a “regular” sole proprietor or a one-person LLC you do not have to file any quarterly forms to report losses, or income.  You simply report the activity for the year on Schedule C of your annual Form 1040.  You would only need to file quarterly reports if you hired employees (you are not be an employee).

TTFN

 

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SEE YOUR TAX PRO FIRST!

I have covered this issue here at TWTP before – but it bears repeating.

A recent discussion thread at a tax preparer Facebook group concerned a potential new business client with three partners and 5 already created “entities” (corporation, partnership). 

Pardon my cynicism (especially when it comes to lawyers) but I expect the 5 entities were created on the advice of an attorney without regard to the tax consequences – an attorney who would get 5 separate fees.

To be fair, an attorney may not necessarily be trying to pad a bill when providing incorporation advice and suggesting multiple entities – but the attorney may not be fully aware of all the tax consequences of the entities, and their interactions, that they propose.

 

Very, very important - if you are considering entering into a business enterprise visit your tax professional and your accountant (if not the same person or firm) before you visit your attorney.  Often times getting out of an entity formed in error can be more expensive than forming the entity. 

It may turn out that you don’t need the attorney at all – a one-person LLC or corporation can be formed easily and inexpensively directly with the appropriate state agency online without a lawyer.  And it is important to be aware that formal incorporation is not always the best way to go for a one-person business (although being an LLC, if not a corporation, is). 

However if there are more than one individuals involved in the business, more often than not you will need a lawyer to make sure that you are fully protected – from your potential partners in the enterprise.  You may need a lawyer to draw up the business agreements for the partnership and your own personal lawyer who represents you alone to review the agreements.

Bottom line – when considering going into business consult a tax professional first!

TTFN

TO INCORPORATE OR NOT TO INCORPORATE - THAT IS THE QUESTION! PART II

In Part I we discussed the tax and non-tax advantages of a corporation. Now for the disadvantages of incorporating.

Fellow tax blogger, and tax attorney, Kelly TAX GIRL Erb provided an excellent review of business entity choices a while back in a guest post at the PROBLOGGER.NET blog titled “6 Types of Business Entities to Consider for Your Blogging Business”. In it she says –

“The disadvantages of a corporation are increased administrative expenses, compliance formalities and the potential for ‘double taxation’.”

These disadvantages all add up to one big one – substantial additional cost! There is no doubt in anyone’s mind that it costs a lot more to form, maintain and eventually dissolve a corporation (whether “C” or “S”) than any other form of business entity.

Kelly tells us that, “Increased administrative expenses are due to more complicated accounting and tax compliance (i.e. filing corporate returns).” And, of course, the substantially increased compliance formalities, substantially more than other forms of business organization, result in substantially increased costs for accounting and tax preparation and federal, state and local taxes and fees.

“’Double taxation’”, Kelly tells us, “is the result of a C corporation being a separate taxable entity and not a pass through. This means that the C corporation pays a tax on its income for the corporate year and the shareholders pay tax on dividends received from the corporation.”

One must consider state as well as federal tax costs. While on the federal level if you have no net taxable income you pay no federal income tax, many states charge a “minimum tax” or “franchise fee” for the privilege of operating as a corporation in the state. My state of New Jersey is especially abusive in this area. A corporation could have “0” taxable income yet still pay from $500.00 to as much as $2,000.00 in “minimum” Corporation Business Tax!

And let’s face it - choosing to incorporate also substantially increases not only your paperwork and expenses but also your potential for agita and aggravation. Because there are a lot more complicated rules a corporation must follow there are a lot more things that can go wrong – and very expensively wrong.

A final disadvantage of a corporation is the potential cost in time, agita (again) and dollars to “dissolve” the corporation. With marriage you can pay a couple of bucks for a licence and be wed by a municipal judge – but you could pay a fortune to get a divorce. It is similar with a corporation. You can easily, and relatively cheaply, incorporate online (I just did it the other day in NJ for $125.00 in about 15 minutes) – but there can be a lot of paperwork and potential expense involved to end the corporation, as well as, once again, the potential for “double taxation”.

When dissolving an incorporated business the best course of action for the seller is to sell the shares of the corporation – which will result in a capital gain transaction on Schedule D of the sellers Form 1040, probably taxed at the lower capital gains rate (which this year could be “0”). However most buyers do not want to do this. They would prefer to purchase the individual assets of the business activity from the corporation. There is no special capital gains tax rate for corporations. A corporation is taxed at regular corporate rates on any gain from the sale of its individual assets. The double taxation comes into play when the corporation, in dissolution, passes on the cash from the sale and any remaining assets to the shareholder(s).

Lawyers love corporations and generally recommend it automatically, regardless of whether or not it is truly the best business entity form for the particular situation. Why? Duh - It generates lots of fees!

One does not need to pay a lawyer an excessive fee (for about a half hour or less of his/her secretary’s time to type a pro-forma certificate) to form a basic one-person corporation. It is a very simple process. And now that many states (like New Jersey) allow one to incorporate easily online with almost immediate conformation it is even simpler.

Obviously with more complicated specific circumstances involved in the individual corporation, multiple private stockholders and/or unique/diverse issues and intricacies, one should indeed consult a qualified attorney experienced in corporate law (including federal and state corporate tax law).

Of course not all lawyers are money-grubbing shysters. There are indeed exceptions who will offer true and honest advice to small business clients based on the individual facts and circumstances. For example in the guest post by tax attorney Kelly Phillips Erb mentioned earlier it is correctly and wisely pointed out that, “In most cases, a C corporation is ‘overkill’ for a freelancer with no immediate plans for expansion, hiring of employees, etc.”

Because of the possible tax savings but guaranteed additional costs involved any individual who is considering incorporating his/her one or more person business should do some very serious number crunching first to determine if there is a true potential cost benefit to making such a choice. It is very important that the first person you consult about such a decision is a tax professional, and not an attorney. It is possible that you may eventually need to consult with an attorney, but certainly not before carefully reviewing all the facts with a tax pro.

My bottom line - unless employee benefits such as health insurance premiums, medical reimbursements and pension contributions are a material issue, my recommendation for one starting out in business is to do so as a one-person LLC electing to be taxed as the “default entity” – with one person that is a sole proprietor filing Schedule C. If you find down the road that you would be better off as a corporation you can always change your form, either by remaining an LLC and electing to revise your tax treatment or by actually incorporating the existing business.

The costs of forming and maintaining and dissolving an LLC are still minimal, especially when compared to the costs of forming and maintaining and dissolving a corporation. As has become true with corporations, it is very easy to form an LLC online at your state’s website. You do not need a lawyer to form a basic one-person LLC.

The final word - Perhaps the most important statement made in Kelly Erb’s above-referenced post is – “Laws vary from state to state as to how various entities are structured {and taxed – rdf}, so check with your tax or legal professional for specifics: I can’t stress this enough.” .

TTFN

TO INCORPORATE OR NOT TO INCORPORATE - THAT IS THE QUESTION! - PART I

As a general rule posts to THE WANDERING TAX PRO are limited to 1040 issues, including those that pertain to Schedule C. While I have prepared many “entity” returns (corporation, partnership, trust, non-profit organization – Forms 1120, 1065, 1041, 990) over the years I no longer accept “entity” clients (unless absolutely necessary).

However, as the decision whether or not to incorporate a business activity is in some degree a Schedule C issue I have decided to address it.

While there are two types of corporations (for income tax purposes) – the regular “C” corporation and the “Sub-chapter S” corporation – I will be addressing only the regular “C” corporation in this post. I feel that the advent of the LLC (Limited Liability Corporation) has reduced the benefit of becoming an “S” corporation.

Every person who is starting a business should not automatically incorporate. In most cases the one-person freelancer, “indie” or small business does not need to incorporate. It only unnecessarily and substantially increases costs, paperwork and agita.

There are several benefits, both tax and non-tax, to incorporating a business.

Historically the most popular non-tax reason for forming your business as a corporation is “limited liability protection”. The corporation has been around for a long time and has been proven in the courts over the years as a way of protecting the personal assets of the business owner(s), or shareholder(s). In most cases the creditors of the corporation cannot take the personal assets of the shareholders to satisfy debts or obligations of the corporation. .

For example, if a customer falls in your store (or spills hot coffee purchased from your fast food restaurant’s drive-up window on his/her lap while driving away) and sues you for $2 Million and wins the court cannot force you to sell your personal residence to satisfy the obligation if the corporation only has $10,000 in assets. Or if your corporation has a loan on which it defaults the bank or other creditor cannot go after your personal assets to cover the outstanding balance if the corporation has no cash.

Of course as with any law there are exceptions that allow lawyers to keep their fees flowing in. If it can be proven that you, as owner of the business, were personally responsible for the fall, or personally “contributed” to the fall, you could also be sued as an individual. And if you, as corporate officer, co-signed or guaranteed the loan the bank can come after you personally to make good. There is no way to get full guaranteed “limited liability” protection in all situations – but the corporation has generally been the best way to get the most protection.

But the corporation is not the only business entity that provides limited liability protection. We now have the “Limited Liability Company” or “LLC”. As one would expect from the title, an LLC provides the limited liability protection of a corporation without all the other “excess baggage” that comes with a corporation. I do believe that all states now allow for a one-person LLC. As long as you follow all the legal formalities, as well as keep your personal assets separate from your business assets (such as by maintaining a separate business checking account – are you listening, June Walker), your liability will largely be limited to your business assets

My only caveat is that, although it has been around since March of 1977 (with the passage of the Wisconsin Limited Liability Company Act), and is now an available option in all states, the LLC is still to some degree the “new kid on the block” and its liability protection has yet to be truly tested in the courts.

One tax-related benefit of incorporating is the fact that a business organized as a corporation will have a lesser chance of being audited than a sole proprietorship filing a Schedule C. If you look at two identical businesses – one filing a Form 1120 (the income tax return for a corporation) and one filing a Schedule C – each with identical gross income and business expenses – there is a much greater chance that the Form 1040 with the Schedule C will be chosen for an audit.

The reason for this is a corporation, with gross receipts that if reported on a Schedule C may be considered to be “large” in relation to other Schedule C businesses, will be relatively “small” when compared to the total population of corporations. And it appears that the IRS will be specifically targeting certain Schedule C businesses for audit in the near future as part of its war on the Tax Gap.

This benefit is most attractive to those who do not want to report all of their income to the IRS and/or who want to overstate deductions or claim personal deductions as business expenses. Tax fraud of this type will be less likely to be caught if one files as a corporation.

As for the honest taxpayer/businessperson who will be properly reporting all income and claiming only legitimate deductions – you should not incorporate if this is your only reason for doing so. It is not worth the additional cost and agita. While nobody wants to be audited, if you are one of the unlucky few who are selected, as long as you have been honest and have kept good receipts and records you should be able to successfully “pass” any audit.

Perhaps the biggest tax advantage of a corporation – especially a one-man corporation – comes in terms of tax-free employee benefits and reducing the overall Social Security and Medicare (FICA) Tax liability.

If you are the 100% owner of a corporation and hire yourself as an employee of the corporation you can give yourself many employee benefits, included but not limited to health insurance, life insurance, reimbursement of medical expenses, and pensions, the costs of which are deductible by the corporation but tax-free to you as an employee.

A major financial benefit comes in the way a corporation pays FICA tax on an employee as opposed to the way a self-employed sole proprietor filing a Schedule C pays “self-employment” tax. An employee pays Social Security and Medicare (FICA) tax on “gross wages”. The employer (corporation) pays half as a deductible expense and the employee pays half via withholding. A sole proprietor pays Social Security and Medicare (Self-Employment) tax on “net earnings from self-employment”, which is basically 92.35% of the Schedule C bottom line. The sole proprietor pays 100% of the tax on his/her 1040.

If a one-man corporation wants to “0” out net income by paying himself/herself a salary he/she can use employee benefits to reduce the “pot” that the wages come from. If he/she starts out with $60,000 and can use $20,000 to pay for legitimate deductible employee benefits, including the employer share of FICA tax, than his salary is $40,000 and FICA tax is paid on $40,000.

A sole proprietor’s allowable “employee benefits” (for himself) are deductible from gross income as an “adjustment to income” and not from net earnings from self-employment. If he/she has net earnings from self-employment of $60,000 he can reduce his income tax by deducting health insurance premiums and pension contributions, but he still pays self-employment tax on $55,410 ($60,000 x .9235) – which is $15,410 more than the corporate employee. The result is $2,358 more in Social Security and Medicare taxes paid.

While a corporation can pay and deduct the medical expenses of an employee under a “medical reimbursement plan” and pay and deduct, within limits, certain life insurance premiums, a Schedule C filer cannot claim medical expenses or life insurance as a business expense on Schedule C to reduce net earnings from self-employment. He/she must claim the medical expenses as a personal itemized deduction on Schedule A, subject to the 7½% of AGI exclusion, and cannot deduct life insurance premiums anywhere on his 1040.

Let us look at the real-life example of a client who has a small retail store. He is currently a one-man “C” corporation. His gross receipts for the year were slightly over $200,000.00. He took a salary of $45,000.00, bringing his federal net taxable income to $2.00. As part of the price for the privilege of living in New Jersey he paid $12,857.00 in health insurance premiums for himself and his family through the corporation. The corporation paid $3,734.00 in federal and state payroll taxes in addition to the $3,681.00 in FICA and unemployment and disability contributions (SUI and SDI) withheld from the $45,000.00 in wages. The Corporate Business Tax paid during the year was $500.00.

If the client had operated as a sole proprietor filing a Schedule C the net earnings on his federal Schedule C would have been $62,093.00 ($2.00 corporate income + $45,000.00 salary + $3,734.00 payroll taxes + $12,857.00 health insurance premiums + $500.00 NJ-CBT). His self-employment tax would be $8,773.00 ($62,093.00 x .9235 = $57,343.00 x 15.3%).

The additional tax paid as a sole proprietor would be $1,358.00 ($8,773.00 - $3,734.00 corporate payroll tax expense - $3,681.00 payroll tax withholdings). There would be a very small federal income tax savings - as the net taxable earnings from self-employment, after deducting the health insurance premiums and one-half of the self-employment tax would be $44,849.00 instead of $45,000.00 – but the state income tax liability would be more due to the increased earnings reported from self-employment and possible decreased medical deduction.

This particular entrepreneur did not make a contribution to a pension plan from the corporation. But if he did that would have further reduced the FICA tax liability. If the corporation had made a tax deductible contribution of $5,000.00 to a SEP on behalf of the owner/employee the W-2 wages would now be $40,000.00. The FICA savings on $5,000.00 would be an additional $765.00.

Of course you must also factor into your calculations the state Corporation Business Tax (which was $500.00 in the above example) and the additional accounting and tax preparation fees that a corporation would pay – and, of course, the agita factor.

And there is another tax-related benefit. A corporation provides you the option to select your “fiscal year”. You do not have to report income and expenses on a calendar year basis. You can, for example, choose a fiscal year of July 1 to June 30, or April 1 to March 30. Having a non-calendar fiscal year can provide some tax planning opportunities for the closely-held corporation.

. . . to be continued

Tomorrow - the disadvantage of incorporating.

TTFN