Question: Married couple live in California, both work as independent contractors, should they form a Delaware LLC and elect to be taxed as a corporation since the corporate tax rate is only 15% on the first $50,000 of profit.
Answer by Wray Rives CPA CGMA:
First off there is no scenario where just forming an LLC is going to save you any tax dollars. Forming an LLC and making an S election might save some tax, but if we are talking $50K of profits, then I don’t recommend an S Corp., if you even qualify.
More tax with an LLC
Forming an LLC in DE will only increase the tax you pay, because now you have to at a minimum pay DE franchise tax starting at $300 each year. It will not avoid CA tax as you will have to register the LLC in CA, assuming you intend to continue living in CA. So you are paying DE at least $300 and CA at least $800 and yet you still owe all the same taxes you were paying before you formed the LLC.
Even more tax with a corporation
C Corp is a really bad idea, because the corporation pays tax at 15% on the first $50K of income, but what is left over is not your money that is the corporation’s money. If you want to spend that money, you have two choices:
- Take a paycheck which is taxable income to you and subject to FICA/Medicare tax, but is at least a tax deduction for the corporation.
- Take dividends which are taxable income to you and are not a tax deduction for the corporation. Here is how that works-$50K earnings taxed at 15% leaves $42,500. $42,500 in dividends paid to you taxed on your personal return at 20–25% (maybe 30–35% if we add CA personal income tax) So you did not pay 15% tax on your income, rather you have paid an effective tax rate of 35–40% before factoring in state income tax.
And even more tax with multiple states
Finally you say you work in multiple states and without having a conversation with you, I probably can’t say what other state you might be subject to taxation in, but know that every state has their own definition of what constitutes doing business in that state. If you operate through an LLC, you could potentially need to register the LLC in multiple states.
The final catch for you is you live in CA and CA has what is known as the throwback rule, meaning because you live in CA, if you have income, even if it earned in another state, but that state does not assess income tax to you, then CA reserves the right to charge you CA tax on that income from the other state.
My final piece of advice is have a conversation with a CPA and then if you decide to go the LLC route have a conversation with an attorney, so you fully understand what you are getting yourself into.