To C Or Not To C, That Is The Question

Robert Flach announced his newsletter, The Schedule C Letter. Robert notes,

THE SCHEDULE C LETTER is a bi-weekly newsletter that provides tax planning and preparation advice, information, and resources for sole proprietors and one-person LLCs who report their business activity on IRS Schedule C

The newsletter, which will be sent via US mail, costs $24.95 for 6 issues. The newsletter will begin publishing in January 2011.

Peter Pappas doesn’t like Schedule C businesses. His view, which I share to some degree, is that any business worth having should be either incorporated or in an LLC that does not file a Schedule C. The primary reason for his view is, I believe, that a Schedule C business has ten times the risk of audit of a non-Schedule C business (all other factors being equal).

Well, I agree to a point. Unfortunately, I deal with one group of individuals who cannot incorporate (or form an LLC) in all jurisdictions. Many states disallow professional gamblers from incorporating because gambling is against public policy (even though it’s legal in that state). My guess is that Mr. Pappas would say that those clients are the exception that proves his rule.

Well, who is right? Mr. Pappas is absolutely correct about the risk of audit. Additionally, for a business that is grossing $100,000 or more, and especially any business of any size with any liability exposure, a business structure (LLC or corporation) is nearly mandatory. Yet what if you are a single member LLC, and you do not want to be taxed as a corporation? You’re going to file a Schedule C.

Perhaps it’s just two individuals looking at an issue from their perspectives. That said, businesses of significant size should definitely look at not filing a Schedule C. And if you do file a Schedule C you should definitely look at Mr. Flach’s publication because making mistakes on your return will cost you time and money.

4 Responses to “To C Or Not To C, That Is The Question”

  1. Russ-

    Thanks for mentioning my new THE SCHEDULE C LETTER, and for the recommendation.

    I do agree that all sole proprietorships should register with the state as a one-person LLC for the limited liability protection – but I definitely do not believe that they should all, if possible, file as a corporation.

    From my newsletter’s sample issue –

    “An LLC can elect to be taxed as a corporation – but if you want to be taxed as a corporation you should, in my opinion, actually incorporate the business activity.

    There exist situations where it may be “more better” to operate your business as a corporation. The decision to incorporate takes very serious study and consideration. I suggest you consult with a tax professional – and not a lawyer – before making such an important decision. It is very important that you review the tax consequences of dissolving the corporation as well. Like a marriage – a corporation me be relatively inexpensive to get into, but very expensive to get out of!”

    And –

    “Do not overreact and incorporate your sole proprietorship, or elect to tax your one-person LLC as a corporation, solely for the reason of avoiding an audit.

    The advice that one should incorporate solely to avoid an audit seems to me to be saying, ‘If you want to cheat on your taxes you can incorporate and the IRS will not audit you’. It is not good tax or financial advice. Be wary of so-called professionals who give this advice – they may be more interested in boosting their fees than in providing you with good advice.

    I have said time and again that an IRS audit is not something that should be avoided at all costs. Tax returns should be prepared, and decisions about choosing a business entity should be made, in such a manner as to generate the absolute least amount of federal, state and local taxes (income and payroll) within the parameters of federal and state laws. If you will pay less tax (income and payroll), fees and other costs by filing a Schedule C you should do so, honestly and ethically, and not worry about being audited.

    If your return is prepared correctly, and you document all items of income and deduction properly upfront, then an audit is nothing more than an inconvenience.”

    I might also add that filing as a corporation has the potential for a lot of unnecessary agita for a small business sole proprietor.

    Thanks again for the plug and for your confidence in my competence as a tax advisor.

    TWTP

    • Russ says:

      I don’t have much to add to what you wrote. I strongly believe that entity formation has three components: tax, legal, and the goals of the owner(s). What is correct for one person may not be correct for a second person. Anyone starting a new business needs to consult both a tax professional and an attorney.

  2. Russ-

    I do agree – but consult the tax professional first, and discuss what the lawyer had to say with the tax professional before taking any action.

    TWTP

  3. There is no ‘one size fits all’ for “to Inc. or NOT to Inc., that is the question”.

    Some Sch C people would never agree to a payroll for themselves, continuing to treat the corporate checkbook as their own. Others will find that a regular payroll and withholding is EXACTLY the discipline they need, as they never understood why quarterly estimated taxes don’t follow a logical quarterly schedule (or whatever other excuse they give as to why they ignored the estimated payment coupons that you gave them last year).

    Certainly the single member LLC is better than no liability protection, but when clients want to add their spouse as owner, we can no longer use the Qualified Joint Venture exception, and a 1065 is mandatory. Adding another level of complexity.

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