Avoid These MISTAKES BEFORE Starting an LLC!

Summary

The 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

00:00

🤵 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.

05:01

🏠 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.

10:01

🏦 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.

15:03

📄 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.

Keywords

💡LLC

LLC stands for limited liability company. It is a popular type of business structure that provides liability protection for business owners while allowing pass-through taxation. The video discusses common mistakes business owners make when setting up and operating LLCs.

💡income types

The video outlines three main types of income - ordinary, passive, and portfolio. Understanding the type of income is important for determining if an LLC, S-corp, or other business structure makes the most sense. Passive income from real estate may fare better in an LLC, while ordinary income with high self-employment taxes could benefit from an S-corp.

💡real estate acquisition

The video recommends setting up an LLC before acquiring investment real estate. This allows the property purchase to be under the LLC rather than personally owned. It also avoids issues with transferring property ownership to an LLC after the fact.

💡EIN

An Employer Identification Number (EIN) is like a social security number for a business. Failing to use an LLC's EIN for banking and tax purposes is a common mistake that prevents establishing business credit and qualifying for COVID relief programs.

💡accountable plan

An accountable plan outlines how LLC owners can reimburse themselves for legitimate business expenses paid from personal accounts. This properly allocates deductions to the business.

💡Schedule C

Schedule C is an IRS form filed by sole proprietorships and single-member LLCs to report business income and expenses. Understanding Schedule C can help LLC owners correctly file taxes.

💡Form 1065

IRS Form 1065 is filed by partnerships and multi-member LLCs. It reports income and expenses separately from individual returns. Partners then receive K-1 forms outlining their share of business gains/losses.

💡SS-4

Form SS-4 is used to apply for an EIN when starting a business. Failing to complete it prevents properly establishing an LLC with key identifications like an EIN.

💡Form W-9

IRS Form W-9 collects information on contractors paid over $600. Having contractors complete it allows properly issuing 1099 tax forms for their services.

💡self-employment tax

Self-employment tax refers to the 15.3% Social Security and Medicare taxes paid by individual business owners on their ordinary income. Understanding how different business structures impact it can optimize an LLC's tax treatment.

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