Avoid These MISTAKES BEFORE Starting an LLC!
Summary
TLDRThe video discusses common mistakes business owners make when setting up LLCs. It explains the importance of knowing your income type to determine if an LLC makes sense, establishing the LLC before acquiring rental property, using your EIN number to build business credit history, understanding the tax forms you must file, properly reimbursing yourself for business expenses paid personally, and more. Following this advice will help business owners avoid issues, qualify for more lending and tax benefits, and properly structure their company finances.
Takeaways
- 😀 There are 3 main types of business income: ordinary, passive, and portfolio. Understanding them helps determine if an LLC makes sense.
- 🏡 Establish an LLC before acquiring investment property to properly protect assets and avoid issues.
- 🏦 Not using your EIN and business bank account makes it harder to build business credit and qualify for loans.
- 📄 Not knowing what tax forms to use (Schedule C, 1065, K-1, etc.) could lead to penalties.
- 💳 Have an accountable plan to properly reimburse personal expenses for your LLC.
- 🚨 Many LLC owners mistakenly think they have passive income when it's actually ordinary income.
- 🤝 Multi-member LLCs file a 1065 while single-member LLCs use Schedule C.
- 😎 The SS-4 form is critical for obtaining an EIN number.
- 📋 Contractors paid over $600 require a W-9 form to issue a 1099.
- 👩💼 Over 31 million Americans own a business, with LLCs being the most popular structure.
Q & A
What are the three main types of income that business owners need to be aware of?
-The three main types of income are: 1) Ordinary income from wages or 1099 compensation 2) Passive income from investments or interest 3) Portfolio income from the sale of capital assets or rental properties.
Why is it important to establish an LLC before acquiring an investment property?
-Establishing the LLC first allows you to purchase the property under the LLC name rather than your personal name. This provides liability protection and avoids transfer issues later when titling the property under the LLC.
What happens if you set up an LLC but don't use the EIN number for banking and expenses?
-Without using the EIN, you miss out on building business credit and income/expense history tied specifically to the business. This can prevent qualifying for business loans, lines of credit, and government aid programs.
What IRS tax forms will an LLC business owner need to become familiar with?
-Important IRS forms include: Schedule C for sole proprietor reporting, Form 1065 for partnerships, Form K-1 for partnership distributions, Form SS-4 to apply for an EIN, and Form W-9 for contractors.
How can an LLC owner properly reimburse themselves for business expenses paid from personal accounts?
-Using an accountable plan, LLC owners can document expenses paid personally but related to the business, and then reimburse themselves from the business bank account while retaining the deduction.
What are some common mistakes business owners make with LLCs?
-Mistakes include not understanding income types, not establishing the LLC before acquisitions, not using the EIN, not knowing required tax forms, and not properly reimbursing personal funds spent on the business.
What makes real estate passive income different from other small business income?
-Real estate passive income is not subject to self-employment tax, while active small businesses are subject to self-employment tax on top of income tax.
When does an LLC need to file Form 1065 instead of Schedule C?
-An LLC files Form 1065 when it has multiple members, making it a partnership. Single-member LLCs can report via Schedule C on the owner's 1040 tax return.
What does obtaining an EIN number allow an LLC business to do?
-Having an EIN allows the LLC to open a dedicated business bank account, build business credit, qualify for loans/financing, and properly file tax returns.
Why are W-9 forms important for LLC contractors and expenses?
-Getting a W-9 from contractors paid over $600 allows the business to issue 1099 forms documenting the expenses to the IRS.
Outlines
🤵 Types of Business Income to Consider Before Establishing an LLC
The first mistake LLC owners make is not knowing the type of income they will receive before setting up an LLC. There are 3 types of income to be aware of - ordinary, passive, and portfolio. Understanding these income types helps determine if an LLC, S-Corp, or C-Corp makes the most sense from a tax perspective.
🏠 Establishing an LLC Before Buying Rental Property
The second mistake is not setting up an LLC before acquiring rental property for liability protection. If the property is purchased personally then transferred to an LLC later, there could be issues with the mortgage company requiring the loan to be paid off due to transfer of ownership.
🏦 Using Your EIN Number for Bank Accounts
The third mistake is not using your EIN number to set up business bank accounts. This makes it harder to establish business credit, qualify for loans/lines of credit, and apply for COVID relief funds since no business income/expenses are documented.
📄 Understanding the Tax Forms To Use
The fourth mistake is not knowing what IRS forms to use for reporting income and expenses. Key forms to understand are Schedule C, Form 1065, Form K-1, Form SS-4 (for EIN application), and Form W-9 (for 1099 contractors).
💵 Reimbursing Yourself Properly
The fifth mistake is not knowing how to properly reimburse yourself for business expenses paid from personal accounts. Having an accountable plan for documentation is key for allocating expenses to deduct on your business tax return.
Mindmap
Keywords
💡LLC
💡income types
💡real estate acquisition
💡EIN
💡accountable plan
💡Schedule C
💡Form 1065
💡SS-4
💡Form W-9
💡self-employment tax
Highlights
There are 3 different income types to be aware of before setting up an LLC: ordinary, passive, and portfolio.
Passive income may not need an S-Corp because it's not subject to self-employment tax.
If labor is involved in a business, it's considered ordinary income and subject to self-employment tax.
Set up the LLC before acquiring rental property so it can be purchased under the LLC name.
Use your EIN number to open a business bank account and track income/expenses for building business credit.
As an LLC owner, understand what tax forms you need to file like Schedule C, 1065, K-1, etc.
Submit an SS-4 form to get your EIN number when establishing an LLC.
Have contractors fill out a W-9 form if paying over $600 to issue them a 1099.
Set up an accountable plan to properly reimburse personal funds spent on business expenses.
3 mistakes not to make with LLCs:
Not using your EIN number is a mistake since lenders want to see business income/expenses.
Not knowing what tax forms to file will lead to paying unnecessary taxes.
Submit an SS-4 form to get your EIN number when establishing an LLC.
Have contractors fill out a W-9 form if paying over $600 to issue them a 1099.
Set up an accountable plan to properly reimburse personal funds spent on business expenses.
Transcripts
as of 2021 there are 31.7
million business owners in the united
states many business owners are setting
up llc's
one out of every six taxpayers that
comes to my office
owns an llc i own six llc's and i've set
up over
5 000 llcs for my clients l to the l to
the c i love saying llc because it
reminds me of ll cool j llc's are the
most popular business vehicles
that business owners set up why is it
that most business owners who have llc's
aren't sure if they should be in llc's
my name is carlton dennis and in today's
video we are going to go over
what you need to consider before setting
up an llc
llc owners make a lot of mistakes i'm
sorry and in today's video i need to
point out some of the mistakes
that you need to be conscientious of
before establishing your llc let's dive
[Music]
in
[Music]
mistake number one is not knowing the
type of income you're receiving
prior to setting up your llc this is
really important and reason why is
because there are three different income
types
you could be receiving and it could
determine whether or not you need an llc
versus an s corp or a c corporation the
three different income types that you
need to be familiar with
are number one ordinary income ordinary
income is everyday income that you work
for
and is typically in the form of w2 wages
or 1099 compensation
the next form of income is passive
income passive income is income you
technically do not have to work for
typically you're familiar with passive
income from investment properties
or interest that you earn off of the
money that you have in your bank account
the third type of income is portfolio
income portfolio income is typically
income that you receive when you decide
to sell capital assets
or if you have capital gains tax from
the sell of a rental property
these three types of income are
important for us to know because it can
help us decide
whether or not it makes sense for us to
have an llc so let's talk about it
number one passive income if we have
passive income what we have to
understand
is that passive income is not subject to
social security tax
or medicare tax that ordinary income is
subject to
so when you think about it it may not
make sense for you to
worry about whether or not you have to
eventually transition your llc to an
s corporation if you have rental real
estate
if your income is passive you don't have
to worry about self-employment tax
so typically a lot of real estate
investors will establish
llc's for their real estate holdings so
if you ever had
the question in your head why do people
set up llc's
as opposed to c corps or s corporations
for their real estate
a big deciding factor around this is
because real estate investors are not
subject to the social security and
medicare tax
that ordinary income earners are subject
to
this leads me to ordinary income
ordinary income is the income you're
familiar with when you're working a job
where you are putting in
labor anytime you're putting in labor
you're going to have to pay into social
security and you're going to have to pay
into medicare taxes
and if you decided to become a business
owner that means you pay into
self-employment tax it's been talked
about in all of my youtube videos if
you've seen them
now one thing that you have to
understand about ordinary income is that
ordinary income
you will pay 15.3 self-employment tax
which is your social security and
medicare
but then you will also pay your federal
taxes and your state taxes
so knowing that ordinary income is
subject to self-employment tax federal
tax and state tax
we have to define what type of business
owners need to know that their business
is actually ordinary income instead of
passive business
let's talk about that i have clients all
the time that'll get on the phone with
me and tell me carlton i have a passive
business i started amazon automation
i'm doing amazon fba i'm selling
products on
etsy i have my online shop any of these
clients that i talk to
that have these businesses that are very
automated
had to work to get to a place where
their businesses are automated
they sat on the computer they figured
out how to put up ads build their
website
hire the contractors and someone else is
doing the fulfillment and dropping off
the orders to the house
that is a business that requires work
and if labor is involved we are subject
to social security and medicare taxes
federal and state taxes so i just wanted
to make sure
that when we go into setting up a llc
that we also understand which type of
businesses
are ordinary income businesses and truly
understanding what would be considered
a passive business last but not least is
portfolio income
i don't really get too much into the
portfolio income unless i'm dealing with
my real estate investors
which i primarily focus on if you happen
to have real estate income
and you decide to sell an investment
property you're dealing with capital
gains it could be short or long-term
capital gains
depending on how long you held on to
that asset but if you're aware of
capital gain income
you might realize that this is actually
categorized as portfolio income to your
tax account
so understanding these three types of
income can let us know
whether or not you should have an llc
that's going to remain as an llc
or if you have an llc that will
eventually be switched to an s
corporation or another desired entity
structure
mistake number two with llcs is not
establishing your llc prior to knowing
that you wish to have a real estate
acquisition
it comes up pretty often that i get on
the phone with a client that told me
that they just bought an investment
property and now they're trying to
decide whether or not it makes sense for
them to have an llc
and i sometimes wish that they would
just have a conversation with me
prior to them buying the rental property
because then i might have advised them
to establish the llc
prior to buying the rental property so
that they can buy the property in the
name of the llc that they establish for
themselves this is a way that we can
completely avoid having your name ever
online
at the accounting assessor's office
saying that you're on title for owning
the property
but then we get to a place where you
want to have that asset protection
because you find out that someone could
slip and fall
and hurt themselves inside of your
property so you eventually want to have
an llc for liability protection
but the property is already in your name
so now we have to decide does it make
sense to
set up an llc and do a quick claim deed
and
re-title your property in the name of
the llc well this is where we can run
into some issues at least i've had
clients run into issues one of the
issues that they run into is this whole
do on sale clause
where now there's a stipulation in their
mortgage agreement that says that
anytime a property is being transferred
or sold
that the mortgage is now due so this is
where we have to be extremely careful
and mindful prior to establishing llc's
into investing in real estate
we have to speak with the tax pro we
have to speak with our mortgage company
we have to determine if we can purchase
a rental property in the name of an llc
and if you're setting up a brand new llc
months before you're trying to buy that
investment property
we need to figure out what we need to do
to make sure that that llc will be
ready to have credit in an income
history report
to qualify for the down payment that you
wish to make through the llc
so these are some things that you need
to be mindful of prior to establishing
your llc
and prior to getting into a real estate
acquisition
mistake number three with llcs is not
using your ein
number for your income and expenses
taxpayer i'm talking to you
you talking to me because if you're
watching this right now you're sitting
back like oh that one's me
why did you set up the llc but then not
use the ein number
this is the one thing that hurts you as
a business owner if you do not take it
upon yourself
to use that nine digit number i believe
it's nine digits
and take it to your bank and open up
your business bank account
then you're not doing yourself a justice
you see when you become a business owner
you can now deviate from using your
personal credit to qualify for things
you can now establish a business credit
card and start purchasing items
underneath your business account
but getting to a place where someone
wants to give you a business credit card
is another situation how do we get to a
place where someone wants to give you a
loan
or give you credit well i want to see a
income history report if i'm a lender
if i'm a bank and i can see reports
showing me
income coming into your bank for your
business and expenses coming out of that
same account
then it's easier for me to justify
giving you a line of credit
or giving you a loan in the year of 2020
i had clients and taxpayers come to me
saying carlton why can i qualify for the
ppp carlton why can't i qualify the
e-i-d-l the
economic injury disaster loan many of my
taxpayers couldn't qualify because they
weren't running their income and
expenses through their ein
number because they set up llcs and
never used
them this sucks because now you're in a
position where you
really needed that money but from a
business perspective you didn't do all
the steps that you needed to do to put
yourself in the best possible position
so what we do is we turn to information
as a part of
watching this video and a part of being
on my channel we want to adopt
information so we can become
savvier taxpayers and that's the goal of
this entire channel
just to make you that much closer to
becoming financially free so one of the
things that you need to make sure that
you're doing
is if you have a business with an ein
number
go to a bank that you feel comfortable
with set up your business bank account
associated with that ein number
and start allocating the income that you
have in the expenses that you have
going back to january into that llc so
that way you can account for those
income and expenses
according to your business all right you
guys are enjoying this let's keep going
mistake number four with llcs not
knowing what type of forms
you're supposed to use now that you're a
business owner this one is a
one that i can't really blame you for
because no one's teaching you what type
of forms you're supposed to use most
cpas aren't doing tax planning which
means they aren't sitting down
educating taxpayers on hey this is this
form hey this is that form
most of them don't provide those types
of services yet but they will
what i will say is if you're in that
position where you're not getting that
level of coaching from your cpa he's
truly just filing your tax returns
then you may not know what type of forms
that you're going to be filing inside of
your tax returns in your first year
business you have to find out the hard
way
after you've already paid some taxes so
what we're going to do is we're going to
go over some of the forms that you need
to be mindful of being self-employed
let's talk about it
form number one the schedule c schedule
c is only present
if you are a sole proprietor business or
you are a single member llc
the reason why the schedule c is
utilized is because the schedule c is
one of the easiest forms
that a tax payer can fill out to report
their income and expenses
a schedule c is just one page it's a
federal return which means it goes
inside of your
10 40 tax returns and it shows the
government
all income items and all expense items
and what you profited which means after
all expenses what you profited
at the end of the year so the schedule c
form is just important for you to
remember but
what i want you to remember is that is a
letter there are tons of different
letters that you could have inside of
your tax return schedule
c is for 10.99 income that you earn
in excess of 400 the next form that you
need to understand
is going to be the 1065 form if you
decide to set up a partnership which
means that you have a multi-member llc
whether it's you and a spouse even a
relative you and a business partner you
no longer file
a 1040 with a schedule c you file a 1065
and you'll have a k1 form that gets
filed in your 1040.
before we go over the k1 form which i'll
discuss with you next let's discuss the
1065.
the 1065 stands for united states
partnership return this means that
you're in partnership with someone other
than yourself
and anytime you're in partnership you
file a separate tax return
outside of your personal tax return so
there are two returns as opposed to
one tax return that a single member llc
would have
if you're a single member llc you just
file your single member tax returns on a
schedule c all inside of your personal
returns if you decide to become a
partnership you have a 1065 over here
and your individual personal returns are
over here
this company will eventually file its
returns and report income and expenses
to you
inside of your personal return so that's
what the purpose of a 1065 form is
now let's go over the k1 form we talked
about how the 1065 receives income when
you have a partnership
and it pays you personally but how does
that transaction happen
well when the 1065 files its tax returns
it submits what's called a k1 form
this k1 form goes to any partner of the
business
if you're the owner of the business and
you have someone else in the business
you have a partnership
both partners will receive a k-1
form that gets submitted inside of the
individual tax returns
and this is where you pay taxes one time
the 1065 partnership business does not
pay taxes
the shareholders who receive their k1s
individually
will pay taxes at their individual rate
inside of their personal tax returns
i hope that made sense so we've gone
over the schedule c the 1065
and the k1 form the next one that i just
want to make sure you understand is the
ss4 form when you go through setting up
your first
llc there will be some steps that you
need to complete in order to make sure
your llc is set up correctly
one of those forms that you'll receive
is called an ss4 form
the ss4 form is a form that allows for
you to apply for your ein number
i have mentioned in other videos that i
view an ein number almost like a social
security number for your business
because it's how your business is
identified it's how you go open up your
bank account for your business it's how
you build business credit with your
business
the ein number is important for you one
thing that i've seen certain business
owners do
is they'll set up their llc half or
partial way
and they won't go all the full extent to
submit the ss4 form to the secretary of
state
please do so obtain your ein number and
now
know what this form is anytime that
you're establishing a new llc whether
it's for a new investment property that
you're thinking about starting
or this new amazon wholesaling business
whatever it is
an ss4 form has to be completed in order
for you to obtain your ein number
last but not least is the w-9 form the
w-9 form
is for 1099 contractors anytime you wish
to hire someone and you're gonna pay
them in excess
over six hundred dollars you need to
have them complete a w-9 form
so that way you can issue them a 1099 at
the end of the year
the w-9 form is how you document who is
actually being a contractor inside of
your business to the government
so you have physical proof that you're
taking the correct steps when you issue
them a 1099 at the end of the year
most business owners will glaze over
this step because sometimes getting into
business can be confusing
on how you're supposed to pay out people
so you'll just end up transferring money
or writing them a check
but you need to be mindful when you're
hiring contractors that when you pay
them over a certain amount
that they need to be 1099 just like
you're a 1099 contractor when you decide
to become a business owner
you also need to know when it makes
sense to 1099 someone else
for services that you're hiring them for
within your organization
number five knowing how to reimburse
yourself as an llc
many business owners get into a mistake
of not knowing how to properly reimburse
themselves
when they are paying for business
expenses that sometime
end up on the personal bank account
let's just say you went into staples and
you forgot your business credit card at
home
and you're buying staples and you're
buying a printer and you decide to pay
for that on your
personal credit card well how are you
supposed to reimburse yourself
how are you supposed to allocate that
over to your business this is where
having an
accountable plan becomes so important an
accountable plan is how you reimburse
yourself
for having expenses that were personal
that should have been allocated over to
your business
there are special rules that you need to
follow in order to make sure that your
documentation
is done correctly so that these expenses
get allocated over to your profit and
loss statement
accordingly if we do this correctly we
can take the business deductions
and you can be reimbursed for the money
that you spent personally
for the business expenses that you
incurred this is extremely important
that we focus on understanding what an
accountable plan is
early on as business owners because we
could be in a place where we're paying
for a lot of items personally
that really are business items but we
may not have set up our business yet or
don't have our business card established
so now we can be in a place where we can
allocate those expenses over to business
and be reimbursed for it
my name is carlton dennis if you guys
enjoyed this video today i'd love for
you to do something for me feel free to
like comment subscribe so i can continue
to make more videos like this for you
i'll see you on the next one
you
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