I have a sole proprietorship & I intend to form an LLC. I want to get my EIN; should I wait til i form the LLC

Question

I would really like to file for my EIN number now. Does it matter if it is done before or after the LLC is formed?

Answer 1

Yes it matters. Since the LLC doesn't exist yet, you cannot get an EIN for it. If you get one now, it will be for your Sole Proprietorship. Once you form the LLC you'll need to get another one since EINs cannot be transferred from one legal entity to another.

Answer 2

Start a LLC and you accountant will love you even more than the IRS does.

There is no tax advantage that I know of that comes with converting from a sole proprietorship Schedule C, to a LLC, S or C corporation.

I have heard some tax preparers say that the tax advantage is you get to deduct ½ your social security taxes as a business expense or that you can pay yourself a reasonable salary and take the rest of your profit as a dividend or other investment income. Another reason I hear frequently is you should change for civil liability.

The first reason of deducting ½ your social security tax is false. Self employed people pay self employment taxes at 15.3 % of net profit. If you are an employee of an LLC or corporation you pay 7.65% of your wages for social security and the employer pays 7.65% of your wages in social security taxes 7.65 + 7.65 = 15.3. There is a small advantage here to the Schedule C because the formula for self employment taxes is
Net profit X 92.35% X 15.3% = Self Employment Tax. The sole proprietor then gets to deduct ½ the SE tax as an adjustment to income.
Being able to pay yourself a salary and claim the rest of your profit as investment income or better yet calling it a dividend sounds like an IRS auditor’s dream to me because if the percentage of profit claimed as dividends is any more than 5 or 6 % it would be disallowed in an audit. Most people would be temped to way overdo this and there are two things wrong with this idea. First reason; If you are a passive investor, you are a share holder; you might have voting rights but you don’t participate in the day to day running of the company and the profits you make aren’t subject to self employment tax. If you participate in the day to day running of the company your profit is subject to SE tax (where is the advantage over being a sole proprietor?). Second reason; not all investment income is subject to the lower capital gains rate; examples are interest and rental income. While some dividends are subject to this lower tax rate, the kind a S-corporation or LLC (private company) would pay aren’t. To be eligible for this lower rate the dividends must be “qualified” or from public US companies.

The other reason I frequently hear is to shelter you from liability. This may be partially true but I wouldn’t make incorporation a substitute for good liability insurance. Let me explain. Lets say that you drive a truck as an for a living. If you were an employee and you had caused accident, the person whom you harmed would sue you and your employer; which also happens to be you, if you own a S- corporation or LLC. You could still lose everything.

Converting to a C corporation is even worse, there are no standard deduction, itemized deductions, or exemptions for a C corporation; the very first dollar of profit is taxed at a higher rate than individual rates.

So when should you convert to a LLC or corporation? I think you should if you are concerned about the liability that you employees might cause you. Remember the truck driver example? If the driver was you employee and you were a sole proprietor you could lose everything but, if you were a corporation you could only lose your business assets. Another reason would be when your business grows so large that you have to hire someone to run it or parts of it for you, when that happens you might really be a passive investor. Another reason might be you like the prestige of owning Joe’s Computers INC instead of just Joe’s Computers.

Keep in mind that I am not an accountant. I am a tax professional who specializes in individual income taxes. You should consult you tax professional for advise on what is right for you. If you really want to pay less in taxes; do things like put more money in an IRA, buy some stock in a good company or some mutual fund shares, buy the building you are renting now so you can take advantage of appreciation when you sell down the road or buy some good rental real estate. For most small businessmen the only thing they accomplish by incorporating is making their life more complicated, with higher accounting fees, while increasing your chances of an audit.

If there is something I haven’t thought of I hope some accountant lets me know. I would like to learn more about business taxes.