This is an important question. How you are organized for tax purposes can make a big difference in how much you pay.
For restaurant owners, I give this advice:
If you are a small business (not a rental property) and you own 100% of it, then a Single Member LLC is a good choice. It only requires one schedule (Schedule C) on your personal income tax return at a relatively low preparation cost. In contrast, a partnership or S Corporation requires its own separate tax return for which there is a significant preparation cost plus certain procedures you must follow. The down-side to the Single Member LLC is that all income you earn is subject to self-employment taxes which are approximately 12 %.. If your income is high enough, you may want to consider changing to an S Corporation.
If you are a small business and you own 100% of it, but you are making significant money, the S Corporation has the ability to save you tax dollars. In theory, if you are making considerable profits beyond what you would take as a salaried worker, you can define those profits as dividends. Dividends from an S Corporation are not subject to self-employment taxes so you save the 12 % mentioned above. You should consult with your tax professional before making this move because there are technical issues that must be addressed. The down-side to the S Corporation is that a separate tax return is required so that cost should be considered.
If you have multiple owners, you could choose to operate as a Partnership LLC or as an S Corporation.
The biggest practical differences for restaurant owners between a Partnership LLC and an S Corporation are the following:
In a partnership, owners cannot be on the payroll like other employees. All checks issued to partners are partner distributions and are subject to self-employment taxes. A working partner can take additional monies for working and that is called a Guaranteed Payment. Partners who take distributions in most cases must pay estimated tax payments quarterly. The biggest benefit to a partnership form of doing business is that distributions of profits, losses and capital can be changed as partners see fit.
So, for instance, if one partner contributed all the money and wants to take all profits until he/she is paid back and then once he/she is paid back, profits can be split evenly, that can be done in a partnership. It can not be done with an S Corporation.
In an S Corporation, all profits, losses and capital must be assigned or distribution in proportion to stock ownership. So if you have a three person S Corporation with stock ownership of 40%, 50 % 10%, all distributions of profits, losses and capital must be done 40-50-10. The upside for the S Corporation is that owners can be on payroll and no estimated taxes have to be paid on that money. In addition, profits can be distributed as dividends the same as mentioned above with no self-employment taxes due on that money.
All LLC’s referred to above and S Corporations, except for rare exceptions, provide the same legal protections, so that does not have to be a determining factor in your decision.
These are the general rules and applicable for most restaurant owners. There are other differences having to do with tax basis, borrowing and other technical tax determinations but these are beyond the scope of this article.
It is an important decision and should be made before you file for a federal ID #. That is why we recommend that you consult with a good tax accountant before making your decision.