Consulting Success: Legal Business Entities, and the Expectation of a CPA

Members of ConsultantFriends.com:

As a CPA, it is my passion to help entrepreneurs like you to become more successful business owners. It is my great pleasure to announce that I will contribute a series of articles that are specifically written to help propel you and your businesses to a higher level of success. It is impossible to cover every nuance here so please contact me directly should you have any questions.

Let’s dive into Chapter One: Leap of Faith.

This chapter covers two important topics: legal business entities, and the expectation of retaining a personal CPA for your long-term success. By understanding these topics, it becomes a lot easier to jump start the process of becoming a successful business owner.

Legal business entities

I would like to briefly mention three major benefits of setting up a legal business entity as opposed to remaining as a sole proprietor.

Conducting businesses as a self-employed individual presents a great risk in terms of liability claims. If anything should go wrong in your business (e.g. insolvency, malpractice, accidents) and you are sued for damage, your personal assets could be in jeopardy. That’s why a smart business owner forms a legal business entity. Its primary purpose is to afford oneself with limited liability protection.

The second great benefit of running your own company is the flexibility to manage the amount and timing of income and expense items. There are many legal ways to accelerate and defer these items to meet your specific personal and business needs.

Lastly, audit risk is greatly increased on a tax return with a Schedule C (where a sole proprietorship reports its income and expense) because a self-employed owner is generally more likely to co-mingle personal assets with company assets. Business deductions receive more scrutiny as a result of claiming personal expenses as tax deductions. By forming a legal business entity and file a separate set corporate income tax returns, the audit risk is considerably reduced.

Now let’s take a look at the two most common forms of legal entities: corporations and partnerships.

A corporation known as “C Corp” has the following features and compliance requirements:

  1. Ideal entity choice if you plan to become a public company
  2. Any person and any entity can be shareholders
  3. Establish and maintain basic corporate records:
    -Bylaw
    -Organizational meeting
    -Stock register
    -Shareholder meetings (at least once annually)
    -Board of directors meetings (at least once annually)
    -Meeting minutes
    -Statement of Information (annually)
  4. The company pays federal and state income taxes based on its profit. The California tax rate is 8.84%
  5. The shareholders only pay taxes on the wages and dividends received from the company
  6. Payroll processing if you hire employees:
    -Withhold payroll taxes from the employees
    -Payroll tax deposits are due either monthly, quarterly or annually
    -Payroll tax returns are due both quarterly and annually

Another type of corporation is known as “S Corp” (affectionately stands for “small corporation”) has the following features and compliance requirements:

  1. Popular choice for sole owner/employee such as an IT consultant
  2. It must be a US corporation
  3. Shareholders must meet and maintain all of the following eligibilities at all times:
    -Only US citizens and residents
    -No more than 100 shareholders
    -Only issue one class of stock
    -Cannot be partnerships, corporations
    -Some specific trusts and estates are allowed
  4. Establish and maintain basic corporate records: same as C Corp.
  5. The company generally does not pay federal income tax. The California tax rate is 1.5%.
  6. The shareholders receive profit sharing from the company and pay income taxes on their personal income tax returns
  7. A sole owner/employee must issue a payroll and report on Form W-2 for himself. The payroll amount must be reasonable comparing to the amount of income generated in the company

If you and your best buddy want to form a company and conduct business together as partners, you should consider a Limited Liability Company (LLC). It has the following features and compliance requirements:

  1. This is a good choice if you want greater flexibility in sharing profit, and significantly less compliance paperwork than corporations
  2. Any person and any entity can become a partner
  3. Establish and maintain an Operating Agreement
  4. Statement of Information are due once every two years
  5. The company generally does not pay federal income tax
  6. The LLC partners receive profit sharing from the company and pay both income taxes and self-employment taxes on their personal income tax returns

California LLCs are subject to the following franchise taxes:

  • An annual fee of $800, regardless of your profitability
  • A gross receipt fee based on the gross income you generated

CPA for your long-term success

It is very true and I have seen more than a fair share that when you hire cheap CPAs, you get what you pay for. Imagine that you pay a bookkeeping fee of $150 per month or a $40 tax return filing, how much time or attention can you really expect to get from the CPA for these cheap prices?

A trusted CPA advisor who is passionate for your success and who is willing to walk side-by-side with you throughout the long journey? Priceless.

Knowing that the fees can be expensive, you should adhere to the following guidelines to make the most bangs for your bucks:

  • During the first 2-3 years of your business, insist that your CPA do your bookkeeping on a monthly basis. Then find the time to sit down and review the financial statements with the CPA. If this is done consistently, the CPA should be able to spot emerging issues and tax saving opportunities that can be implemented on a timely basis.

This is exactly what I have always done in my practice. I help put my clients on the right tracks and their businesses would naturally grow.

  • When your business is growing bigger and busier, it naturally creates more daily accounting tasks (e.g. paying vendor bills, collecting payments from clients) and complicate payroll (e.g. 401(k), vacation accrual, medical benefits). I personally believe it does not make sense for your CPA to keep doing these works for you at this point. The CPA should recommend you hire additional accounting staffs or use a reputable payroll processing company.

My experience tells me that this will free up the CPA to focus more on the strategic directions of your business by overseeing the high level accounting and tax compliance works. You will definitely get more value out of the money you pay here than to bog down the CPA with non-value adding tasks.

  1. Promptly respond to your CPA’s request for information. For CPAs like us, there’s nothing we hate more than waiting for that last piece of information to wrap up a tax return or to complete the financial statements. Once we lose the train of thought and put your case on hold, it might be a while before we take it up and spend a lot more time to review the case again.
  2. Many former clients of mine seemed to believe that the little CPAs like us are not only accountants, but also magicians who can make numbers appear and disappear as they wish. Nothing could be so far away from the truth. And that’s why they are now my “former” clients.
  3. Don’t forget that we CPAs are also human beings just like you so we can also make mistakes. A good CPA usually will own up the mistake right away and fix it without charging you.
  4. These are only guidelines based on my experience. There is no one-size-fits-all solution. A good CPA should be flexible and adapt his service to your particular needs at a particular time of your business cycle.

Aspiring IT Consultant

To close out this chapter on a high note, let’s take a look at the example below. It involves an aspiring IT consultant who wants to retain a personal CPA advisor, and wants to know what to expect from this new exciting endeavor.

Starting point:

  1. The consultant sets up an S Corporation in California
  2. Annual income of the company is $150,000 a year
  3. He has a wife who works as an employee elsewhere, earning $80,000 a year
  4. They own and live in the same primary residence for 3 years
  5. They rent out 2 properties with gross rental income of $48,000 a year
  6. They plan to buy more properties every now and then and rent them out
  7. They occasionally trade stocks
  8. They wish to develop a side business

Scope of works for the CPA:

  1. Help set up the S Corporation and maintain corporate compliance throughout the life of the corporation
  2. Perform monthly bookkeeping and payroll processing for the S Corporation:
    – Bank statements reconciliation
    – Credit card statements reconciliation
    – Create employee paychecks and pay stubs, direct deposit option is available
    – Withhold payroll taxes from employees
    – Timely deposit payroll taxes with the tax agencies
    – Timely file payroll tax returns
    – Review financial statements with the consultant
  1. Prepare the S Corporation tax returns
  2. Prepare the couple’s personal income tax returns that include the profit sharing received from the S Corporation
  3. Help keep track of the rental income and expense
  4. Advise on how to manage the amount and timing of income needed to facilitate the purchase of additional real estate properties
  5. Explore ideas and lay the ground work for the side business
  6. Review the wife’s pay stubs and her participation in the company’s benefit packages to ensure a comprehensive coverage of the couple’s personal and business finances
  7. Handle correspondence with third party entities such as tax agencies, local governments and financial institutions
  8. Always be ready for special projects that are out of the normal scope

With most of the essential tasks taken care of by the CPA, the consultant can have a peace of mind and fully focus on what he loves to do best: his IT consulting works. A monthly fee for basic CPA services could start from $800. A full service package could cost at least $2,000 per month. There is usually a separate fee for the tax return preparation service. In my practice, I also provide complimentary tax planning sessions throughout the year.

Are you ready to take this leap of faith? Allow me to hold your hands and let’s enjoy the journey to your success together.

 

About Author:

 JamesWong, CPAJimmy W. Wong, CPA left the comfort and stability of Corporate America and started his own consulting firm with a true passion to help business owners succeed in their endeavors. He is a certified public accountant, an IRS enrolled agent, and a member of the American Institute of CPAs.

Jimmy graduated from California State Polytechnic University Pomona with a Bachelor’s Degree in Accounting. He is currently studying for a Master’s Degree in Business Taxation at the University of Southern California.

Jimmy can be reached at (909) 999-8366, 333 Paseo Sonrisa, Walnut, CA 91789,  novacenturyllc.comjimmy@novacenturyllc.com. His company profile is listed on Our Advisors directory.

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