If you are a network marketer, whether full-time or part-time, you can benefit from forming a corporation or an LLC. There are two reasons why; one has to do with lowering your taxes and the other, with growing your business.
First, no matter what your level of involvement in network marketing, you are going to make income. As a business owner, your goal is to have that money taxed at the lowest rate allowed by law. If you are doing this business as a sole proprietor, you are going to pay more taxes than if you operate it as a corporation or an LLC. Period.
Second, you are involved in a business. Part-time or full-time, every business owner wants their business to grow and become more successful. If you are a sole proprietor, your business cannot grow to its full financial potential because it is limited to you. Here is why:
Sole Proprietorship versus Corporation or LLC
If you are doing business as a sole proprietor, you will probably receive a Form 1099 after the end of the year that shows your gross income for that year. After you claim all expenses you are eligible for, the remainder will be your taxable net income, which is now subject to self-employment tax, which means that almost every dollar of income is taxed at your highest possible tax rate.
However, if you are operating your network marketing business as a corporation or LLC, even with the same amount of income, the end result could be quite different. With a corporation or LLC, the tax code allows you to take income out of the business in six different ways: wages, fringe benefits, dividends and distributions, loans, rent, and royalties. Let's look at the four most important ways for network marketers.
Wages consist of the income you take out of your business as remuneration for your efforts, and they are taxed at the same rates as our sole proprietor example.
However, as the owner of a corporation or LLC, you can regulate this income in a variety of ways. For instance, you could take some income out as wages, or you could flow the income into one of the other six categories mentioned above so that it is taxed at a lower rate (if taxed at all). This is called regulating income. In essence, you have the ability to change the character of money—an option the sole proprietor does not have.
2. Fringe Benefits
Fringe benefits are legislative tax rules that allow businesses to write off non-traditional business expenses, such as health insurance and retirement plans. Owners of corporations and LLCs can claim these fringe benefits for themselves. The cost thus becomes a business expense and the business can write it off, effectively reducing the business's taxable income. If a sole proprietor were to claim a fringe benefit, it would almost invariably be characterized as income to him and be taxed accordingly.
3. Dividends and Distributions
A dividend or distribution is considered the profit a business makes. It can be given to an owner throughout the year or at the end of the year. The key here is the classification: since this income is not classified as wages, it is not subject to employment tax. Every dollar paid out as dividend saves the owner 15.3 percent—the going U.S. employment tax rate. Who makes this classification? Whoever is writing the company's checks!
A corporation or LLC is considered a separate legal person. You are the owner, but you can still interact with it as a separate person, which means you can borrow money from it. The obvious benefit? Any money you borrow is not considered taxable income. Sole proprietors cannot enjoy this benefit, because they are not considered separate from their business.
The reality of business taxation is that there are simply more opportunities to lower taxes for corporations and LLCs than there are for sole proprietorships, and it's good business to learn the rules and take advantage of them. As a sole proprietor, you will always pay more in personal taxes.
We all want our businesses to grow and become more successful. However, growth can be different from success.
First, as we saw above, we can make the exact same amount of money as we made last year but end up paying less in taxes if our business is structured differently, and thus keep more of the money we make.
Second, growth is not simply about expansion of the business. We also want our business to grow independent of us. As a separate legal person in the eyes of the law, your corporation or LLC can grow independently of you. It can develop its own financial identity, for example, establishing credit for itself independent of the owner. Which means your business has the ability to have unlimited growth potential.
Another interesting aspect of this separate identity is that any credit you have, as an individual, is considered a debt. Any credit the business establishes for itself is an asset. If the business is ever sold, that will add to the value of the business—another feature that is not available to the sole proprietor.
If you want to become more successful, you are better off operating your business as a corporation or LLC. Remember, part-time or full-time, this is a business. No matter how much time you spend in it, you always want to make sound business decisions.
SCOTT BURNETT, Esq. is considered one of the
nation's leading authorities on asset protection and
tax education for corporations and LLCs. A highly
sought-after trainer and speaker, he is the producer
of the Lawsuit, Audit Protection Service (LAPS)
that provides compliance protection for small businesses.