SYRACUSE — A partner at Dannible & McKee, LLP on Jan. 31 spoke at the Syracuse Tech Garden, addressing entrepreneurs on issues they are facing in the startup phase of their businesses.
Michael Reilly spoke on topics that included accounting impact in their choice of operating entity and the tax implication of knowing how to classify their workers as either employees or independent contractors.
Attorneys from the Wladis Law Firm, P.C. joined Reilly for the presentation.
Reilly also spoke with The Central New York Business Journal in a follow-up conversation on March 21.
Choice of entity
Reilly addressed the accounting advantages and disadvantages of four types of business entities, including a sole proprietorship, a partnership, a corporation (either a C corporation, or an S corporation,) or a limited-liability company.
If someone starts a business as the sole owner, he/she can choose to form a sole proprietorship, and the accounting is “relatively easy,” Reilly says.
The owner can use the cash-basis method of accounting, depending on the business.
“All the information gets reported on their personal return, using a form Schedule C,” Reilly says.
However, the problem with a sole proprietorship, he notes, is the owner faces the potential for liability issues because the individual isn’t protected from the business because they are one and the same.
“For example, if the business got sued, you as the owner would also be involved in that lawsuit,” Reilly says.
He describes a partnership as an entity that is similar to a [sole] proprietorship, except that it has two or more owners.
The owners are required to file a separate partnership return, Form 1065, making it a “little bit more complicated,” and the liability issue remains, Reilly says.
If the partnership faces a lawsuit, each of the partners would be liable, he adds
Entrepreneurs concerned about liability could consider forming a corporation, according to Reilly.
He explained that one of the differences between a C corporation (a regular corporation) and an S corporation is that a C corporation pays its own taxes on all the income it earns.
“And then when those earnings are distributed, the shareholder would pay taxes on them again,” Reilly adds.
For example, if a person bought stock in Microsoft, the firm pays its own taxes and then the shareholder gets a dividend. The shareholder pays taxes on the earnings again in a regular C corporation. In an S corporation, however, all the earnings effectively flow through the owners, so the owners pay taxes on the earnings.
“So it’s a one-time tax,” Reilly says.
Forming an S corporation is similar to a partnership in terms of taxation, he says. In a partnership, the partners are taxed on all the earnings, and same process applies to an S corporation.
The difference between an S Corporation and a partnership are the limited-liability issues, Reilly says.
“If the corporation got sued … that entity would be sued but the individual shareholders would not be sued unless they were personally negligent … Therefore it gives [an entrepreneur] liability protection,” he adds.
And that’s the primary reason why an entrepreneur would choose to form a corporation, so whether you’re a C corporation or an S corporation, you’ve got limited liability.
The fourth possible type of entity is a limited-liability company (LLC), which is “kind of a hybrid,” he says.
“It’s really a partnership that’s got limited liability like a corporation,” he adds.
If a partnership faces a lawsuit, the individual partners are also liable. A lawsuit against an LLC can target its assets but not the individual members, which makes it similar to an S corporation.
Entrepreneurs like the partnership format, but they don’t like the liabilities involved, so that is why some choose the LLC option. LLCs provide corporate protection, but entrepreneurs are taxed in the same way as a partnership, Reilly says.
Employee or independent contractor
Reilly also discussed what qualifies a worker or service provider as an independent contractor rather than an employee, and the tax implications involved.
Business owners can use a 20-factor test that’s part of the IRS ruling 87-41, Reilly says.
The factors involve an employer’s control over the individual, he says.
If the owner controls when the person arrives for work, what tools the person uses to complete the job, and the space the person needs to execute the work, then that individual is under the company’s control.
“Then the IRS can come back and say … they’re an employee, not an independent contractor,” Reilly says.
The IRS could then reclassify that worker as an employee, if the owner was choosing, just arbitrarily, to treat the person as an independent contractor to avoid the payroll taxes, he adds.
At the same time, if that worker operates another business or works for someone else and the entrepreneur just needs a job completed, then the independent-contractor qualification will likely apply.
“We’re not going to control, direct, or supervise you. You just take care of it. In that case then, they’re going to be more in the nature of an independent contractor,” Reilly says.
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