Secrets to Keeping the Money: Should Your Home-Based Business Be an LLC or Corporation?

Successful home-based business owners understand that three factors determine the bottom line: income, expenses, and taxes. Network marketers, whether home based or not, are in the business of creating residual income streams. Some work in multiple programs; others master one and devote their time to growing that single empire. However, the owner of every successful business who makes it big from the comfort of his own home eventually has to wrestle with the facts that people are sue-happy, and Uncle Sam wants to take 15 percent of the profit off the top as self-employment taxes.

Three Secrets. As an attorney with more than a decade of experience advising small business owners, I will share with you three secrets to keeping the money.

1. Do not be a sole proprietor. Many attorneys joke that “sole proprietor” is a Latin phrase meaning “unlimited personal liability.” The only business form worse than sole proprietor is a general partnership–in which each partner is personally liable for the other partner’s negligence.

2. Choose to be an S corporation. S corporations are taxed in a way that is closer to partnership taxation than to corporate taxation. Traditionally, this has been the entity of choice for people in passive income businesses such as network or affiliate marketing. S corporation owners must take a “reasonable salary” that is subject to self-employment tax, but S corporation distributions beyond that salary are not subject to self-employment tax.

3… Or choose to be an active/passive limited liability company (LLC). Under proposed regulations, network and affiliate marketing LLCs can avoid self-employment taxes on a vast majority of their revenue if they have two owners, at least one of whom spends less than 500 hours per year on the business and has no management rights. Because there is no “reasonable salary” expectation built into LLCs’ partnership taxation, this may be a more attractive option for many network or affiliate marketers.

Corporations and LLCs each bring limited liability, presuming you follow a few corporate formalities. The first step is to discuss which structure works best with your accountant and your attorney. Once both understand your goals, they can help you form and maintain your entity of choice.

Two Examples. My law practice is organized as a C corporation, which allows me to deduct fringe benefits that I would not otherwise be able to deduct. Because my corporation’s revenue is derived from my personal services, I need the corporation to pay me a reasonable salary, for which I pay the equivalent of self-employment tax. If I had associates producing substantial income for me while was at home playing with my children, an S corporation might be a better choice-because the revenue from the associates’ work would be passive income, which I could distribute to myself without paying self-employment tax.

By contrast, my affiliate marketing income is almost entirely passive. Once I have introduced a business owner to the concept of earning a commission on its own credit card processing fees, I actually do earn revenue while at home playing with my children. Because this income is almost entirely passive, I am organizing my affiliate marketing entity as an LLC with 5 percent active and 95 passive ownership interests-meaning that I do not pay self-employment taxes on 95 percent of the income. That structure alone keeps 14 percent of my total revenue in my pocket that otherwise would go to Uncle Sam.

With thought and planning, you can enjoy more of your hard-won revenue streams while keeping your home safe from creditors. As always, you should consult your own attorney and accountant for advice about what best works for you.