Wealthy & Wise: When is the Right Time to Set up your LLC?

Adam:

Welcome to another edition of Wealthy and Wise. I’m your host, Adam Kintigh. And today we are so lucky to have in-studio live Mr. David Chafkar, himself. Absolute wonderful man has been very knowledgeable in coaching and instructing business owners and investors for many, many years. And today we’re talking about the exciting topic of when should we form the LLC. And I know it’s for you, David, you’ve been doing this for well over 20 years.

David:

Oh, yeah.

Adam:

And in all these years that you’ve, I’m sure you’ve heard things that are right and things that are wrong. But I’ve always got that people say, oh, as long as your company is formed by December 30th, you are good for this year of 2022. As long as you perform by the end of the year, you’re fine. Is that true or false?

David:

Well, yes. I mean, you want to form the year you are in business, but you want to start the business and start the formation really from day one, you know, tax advantages, asset protection, separation, privacy, liability, you know, all vitally important. But remember, that only starts once that entity is in place, once it’s set up properly. So, to take advantage of the benefits, but without question, you want to make sure it’s done from day one.

Adam:

Got it. So, one of the things that I also look at is from an age standpoint is how valuable is that age? And do they care what how many months you’ve been in business? Is it years? How does that work exactly? Yeah.

David:

Yeah, you know, it’s interesting when you go to get funding from a lender or you’re building credit or things like that, you know, whether my entity is actually formed in November 1st or January 1st, you know, what they base it off of is the actual year of incorporation, you know, which is why you want to always make sure that you get the entity going quickly, especially if your goal is to get initial funding in place as soon as you can. The older the date is always going to be much, much better to get for approvals, lending docs, things like that. You know, because underwriters look at that. They want they want to see how long you’ve been in business, what their criteria is, what type of business you’re in. So, age is always going to play a factor. So that’s a big part of what they look for.

Adam:

So, I was looking at the age side of things and how that ties into the credit and even the credibility, you know, for us here at NCH. Having been in business since 1989, it says a lot about a company being able to weather those storms. And I think even SBA looks at the statistics being that like 80 or 90% of businesses fail within the first two or three years in business. And so having that age getting passed, that help even applying for loans, I’m sure is makes a big difference. So, what’s your experience been on if I’m applying for a loan as a brand-new business versus one applying that is been around a little bit? What are the differences that we’re seeing in approval rates or the odds of being funded?

David:

It all comes down to credit risk. You know, no matter who we are, we’re all submitting an application to a lender. That loan application then goes to underwriting. And remember, the underwriter doesn’t know you, doesn’t know me, doesn’t see faces. All they see is information on an application. That’s it. So, they have very specific criteria is what they look for. And the age of the company for them makes a huge difference that tells them in their mind that you’ve been in business, you’ve weathered some of the storms that many business owners face, especially from, you know, year one, when there’s going to sometimes are growing pains, challenges. You know, the older you can look on a document much, much better for them. They look at that as a really good credit risk and many times will increase the approval rates for the type of lending you’re going after.

Adam:

Obviously, they’re looking at your credit, but all these variables that are coming into play and the data is always an important one. Now, what about from a tax standpoint? So, I always have people that say, well, my accountant said, as long as I get this done by the end of the year, I’m good. What’s your take on that?

David:

You know that’s, it’s interesting because I do hear that quite a bit. Sometimes when you view things the way the IRS view things is sometimes they have a different way they look at things. From a tax standpoint, keep in mind, you know, when you when you create an entity or run a business, you have to, you know, are we required to file legal to obtain tax documents? Yes, of course. You know, we’re required to have bookkeeping. We’re required to have a chart of accounts and are required to have all of these documents. And many times at the end of the year, especially for a startup companies, first year businesses towards the end of the year, we’re asking for a lot of deductions, write offs, tax benefits, you know, things like that that we’re looking for that we get from developing a good business model or entity if properly set up. But the IRS wants to know that throughout that period, if we are going to approve that and not count that as you, because remember, us as individuals may not qualify for a lot of the write offs that corporate America. See, we live in a country referred to as corporate America. Big business has been lobbying for generations, it feels like, you know, to get deductions, write offs, tax benefits, and they get that. You know, that’s why we always encourage individuals from day one to get their entity set up. All the same benefits that companies like Microsoft get, we get. But, we have to show that we’re operating properly, that our entity has an individual. And more importantly, you know, the sooner we can get that incorporated started from day one, we can now start taking advantage of all those tax benefits. And now comes the end of the year when the IRS is looking at that going, should we extend those write offs to you? You know, these are all variables they look at. Do you have your bookkeeping in place? Do you have all these documents in place? Not at the end of the year, from the day you started. Because if I didn’t start the documents in the requirements the IRS has until the end of the year, they’re mine. They make a lot of the tax boards, and they view that as, I was not operating as a real business. So why then should you qualify for the write offs? So, it’s much better from day one to make sure it’s set up properly.

Adam:

That’s a good point. So that I’ve also heard that there are limitations, that there’s only so much you can write off prior to the date of incorporation.

David:

Sure.

Adam:

And what exactly are those limitations and how does that work?

David:

Well, you know, keep in mind, we, as you know, anything prior to incorporating we’re considered a sole proprietor. If we’re really, truly conducting business, if we file the DBA, do we get deductions and write offs? Yeah, but they’re limited. We understand that. They’re going to be much, much more limited on what we can actually take advantage of to really take advantage of all the corporate deductions, corporate write offs, living the corporate lifestyle if you will, and all the benefits that come from it. You know, having that Inc or LLC in place is going to be vital to be able to take advantage of that. Many of the write offs prior to creating my entity are going to be much, much limited. You know, some in some cases they’re based on percentages. I may only be able to write this much off, whereas if I’m incorporated, I can write the entirety off, you know. Many, many different IRS sections and things that become available to us once we are incorporated or, you know, operating under LLC. These are benefits that now we can take huge advantage of prior to we can’t. So, you know, even from a tax standpoint, you know, I’m all about making sure that I put every dollar, every penny of that dollar in my pocket versus what I give away to those darn tax boards.

Adam:

Absolutely correct. So, prior to so, I heard that I had, I was limited to maybe $5,000 in startup cost…

David:

Right?

Adam:

$5,000 in education cost. And oftentimes, you know, look at inflation alone with the cost of things, I can’t buy a gallon of milk for that.

David:

Oh, I know.

Adam:

So, you look at truly those advantages of having that date of incorporation and the tax advantages you get from doing that. So, if you’re thinking about starting a business, it’s probably a good move to go ahead and get the LLC formed immediately so that we can take advantage of all those tax savings that come after it. We talked about the age of the business, the loans, the credibility. Now, what about from a legal standpoint, how does it really work? If I’m looking for asset protection, when is the best time to form the company?

David:

Without question, I want to have it from day one my business is operating. Put yourself in the situation of an individual business owner facing a liability. Whether I’m a real estate investor, whether I’m, you know, running a general business, whatever situation I’m in, you know, I’m banking on the fact that the entity, maybe the state that I’ve incorporated it provides a huge amount of asset protection, legal separation for me and my family. At the end of the day, I don’t want to risk everything that I’ve worked so hard prior to creating the business. I don’t want to risk losing any of that. When a liability is filed, you know, you know, at the end of the day, they will look at that incorporating day to see if you qualify. In fact, some of the new statutes in place now stipulate, you know, because a lot of times when you think of, okay, I’m facing a liability, many people run out, call their legal team up. Hey, I got to get that corporation in place in hopes to sidestep the liability that they know is pending, maybe coming their way or something that could potentially be happening. But nowadays in the courts, they view a liability or how late is it to actually incorporate. Nowadays, they view it, if you have a general understanding that a liability could happen, if something is potentially even foreseen, it doesn’t have to actually happen, then they view that as too late. Many times, you know, if I realize that a liability could be coming down the path, sometimes in many courts, that’s even too late to even start the corporation. So, it’s all about planning. We want to make sure we’re planning ahead. We’re making sure we’re getting our structure in place because entity structuring, one of the best reasons and we’re probably the most sought after reasons is just that, legal separation, protecting my assets. Really, that’s what entities were originally created for. Of course, we get the benefits from taxes and funding and all the other good benefits, but without question, if you’re going to be focusing on creating a good asset protection strategy, you need to start that entity from day one.

Adam:

Yeah, you bring up a very good point. So, from the day one, one of the things that I get questions about a lot is, how about the money I’ve already made from my business?

David:

Right.

Adam:

I’ve been operating as a sole proprietor. I’m forming the LLC. There are some rules behind how I can save in self-employment taxes. What are the things I can write off and how are those things really going to work from the date of incorporation moving forward? How do I have to change things? What do I have to do to take advantage of those tax savings?

David:

Well, I mean, you know, again, all your business entities that you create, there’s certain, you know, to get the benefits that the feds or the IRS have put into place for us to take advantage of. We have to have that document that says we are legally incorporated. Those benefits only apply to us once we have it. Prior to that, those benefits may not be in a full effect. You know, number one, we don’t have liability protection prior to that. You know, a filing, a DBA, David Chafkar doing business as, that means the business is me. I’m the business. You know, until I can create a separate legal entity, a separate legal body, you know, under the federal view of an entity is, they actually considered an LLC or a corporation as being considered to be a citizen or individual. It actually is a standalone individual and that’s where we get our asset protection and tax savings and benefits from. You know, allowing another individual that we create to take on the liability and to provide us substantially increased benefits at the end of the day. So, going back to the, you know, what is able to be written off prior to, many times, you know, once I get my entity, I have to keep a set of books that show from day one. These are the deductions and write offs after my business is created commonly creating a business ledger, personal ledger, personal ledger to show what I paid for prior to the LLC being created. Business letter to show what I what I paid for after the LLC was created. And sometimes that may even force us, sometimes to file two returns separately, one for my DBA sole proprietorship, and one for my LLC. So, you know, obviously if you know you’re going into business, the sooner we can get that entity set up, you know, that will lessen the duplicating of those type of documents. You know, we can now operate in a very, very streamlined manner.

Adam:

Good. So they, if I form a corporation now, we’re kind of in the middle of the year.

David:

Yeah.

Adam:

So, prior to this, I’ve got to calculate as a sole proprietor, effectively, I’m paying the full boat, state and federal, Social Security and Medicare. The second half of the year, that’s what I’m going to be really picking up those tax savings and tax benefits. Then, everything that was done before, I’ve got to keep those records separate. I have a CPA, a tax preparer, tax professional that’s going to take care of that. But starting that date of incorporation, that’s where we’re really going to see those significant savings that you’re talking about.

David:

Substantial savings. In fact, most of the tax savings you recognize, many times in the first quarter of being, you know, operating your business under an LLC or corporation or business entity model, just the tax savings alone, the additional benefits that you’re able to take advantage of more than compensates you for the small cost it takes to create the entity. You know, it’s financially just for me, probably lack of a better term, it’s almost a no brainer. You can’t afford not to.

Adam:

Good. Now, forming a company is one thing with the LLC, corporation, those are everybody’s got a different situation. So, whether it should be a corp or an LLC or things that I’d say we leave up to professionals like you to advise us on what entity type we need and doing it in the right state, depending on the goals and such. But from a tax election standpoint, we have to elect to be taxed properly

David:

Correct.

Adam:

And so, talk to us about that. If I form an LLC, I see a lot of people do it on their own. They form the LLC, they go get the EIN number, they don’t do the proper tax election. What can be done to help those people that just really screwed it up or didn’t know that they didn’t know? How can those people, how can you help those people?

David:

Well, you know, that’s a common thing that happens. You know, many times when we think about creating an entity, many people starting a business, they go locally to the state. They, you know, they pay the fees to get their LLC and they end up, you know, they get the documents that says they are, you know, an LLC legally. And you know, without choosing a good proper tax election, you know, without understanding how our business, you know, the type of income we’re generating, what category it falls under, you know, it’s going to be vitally important to choose a proper election. You know, this is why under the corporate tag, there’s a lot of different types of corporations, S corp, C Corps, you know, personal holding corporations, you know, so forth and so on. Same thing with LLCs, you know, they can be taxed in different tax formats. There’s a reason for that. You know, each tax election provides a certain type of tax benefits that can massively increase the amount of benefits we could take advantage of from a tax standpoint. Many times, not knowing the proper tax election can reduce the amount of deductions and write offs and tax benefits we can actually take advantage of. So, when we do talk to clients, going back to your point in question, one of the things we look at, you know, is really there’s, you know, sort of a checklist of questions, what type of business you’re operating, what type of income you’re, you know, are you generating, you know, what your goal was, your what your objectives. And from that, we can start to really determine what’s going to be the proper election for them to operate under so they can take advantage of all the benefits, you know, and really maximizing all the benefits. That’s really important. And even sometimes if you’ve actually gone out and actually you’ve incorporated yourself or created an LLC prior, you know, once our team starts working with you, we can even go through many times and actually help adjust the election, make sure it’s aligned properly, not only with creating a new one, but sometimes I’ll even take a look at what someone already has maybe with prior businesses. The goal is, to sort of align them all together. You know, and why do we align them? Well, again, for tax benefits, but, you know, really for asset protection. You know, there’s no real one thing you can do to get complete asset protection. Asset protection is all about the alignment. It’s how your structure is aligned, determines the benefits you get. So, this is something we will commonly look at, right you know, really on the first consult.

Adam:

Well good. So, David, we so appreciate you taking time out of your day to be here. And for those of you that are watching, make sure you hit the like unsubscribe button. Share this with your friends and family. But if you’re thinking about starting an LLC, not sure when the right time is. Call our office and talk to experts like we have here, David Chafkar, that can kind of get you the holistic view of what you’re doing, how you’re doing it, and just make sure you’re doing it right. I always say it’s those little mistakes that get very costly later on. So, we want to make sure that we help you avoid those costly mistakes working with professionals like David. So, thank you so much. Have a great day!

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DISCLAIMER: The above material has been prepared for informational purposes only, containing opinions of the provider, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.