Choosing the wrong business structure can cost your company thousands of dollars per year in unnecessary tax payments. Unfortunately, this is a common mistake made by small business owners in Wisconsin. It’s not intentional. Entrepreneurs and startup founders often misunderstand the options available to them. This article will cover the following:
- The differences between sole proprietor, LLC, S-Corp, and C-Corp
- Choosing between calendar year-end and fiscal year-end
- Business structure nexus rules to operate in multiple states
Many business owners consider personal liability to be the top concern when choosing a business structure. That’s important, but the decision should be more about tax optimization. For instance, the difference between being a sole proprietor and electing to be an S-Corp could be thousands of dollars in tax savings. Our first entry below explains how.
1. The Solo Act Mistake: Staying Too Long as a Sole Proprietor
The benefits of being a sole proprietor basically end when the company’s revenue hits the $50,000-$75,000 range. Going solo works in the beginning because it’s“simple, but business owners in this position pay a self-employment tax of 15.3%. That’s 12.4% for Social Security and 2.9% for Medicare. Here’s an example of what that looks like:
- A Wisconsin consultant, operating as a sole proprietor, earning $80,000, pays $12,240 in self-employment taxes, not counting federal and state taxes.
- The same consultant, operating as an S-Corp, and taking $50,000 in salary, pays $7,650 in self-employment tax, saving $4,590 annually.
- Only the salary portion is subject to payroll taxes
Compound this over five to ten years, and you’re looking at $23,000 to $46,000 in unnecessary tax payments. That’s money that could have been reinvested in your business or saved for retirement. You can even take a vacation from time to time.
2. The LLC Trap: Missing the S-Corp Election Window
The Limited Liability Company (LLC) business structure is popular in Wisconsin because it provides liability protection and operational flexibility. That part is common knowledge. What many LLC owners don’t know is that they can elect to be taxed as an S-Corp, eliminating potentially thousands of dollars in self-employment taxes. Here’s what that looks like:
- A Milwaukee LLC earning $120,000 annually pays $18,360 in self-employment taxes
- With an S-Corp election and $60,000 reasonable salary, payroll taxes drop to $9,180
- Annual savings: over $9,000
- Five-year impact: $45,000+ in tax savings
Wisconsin conforms to the federal S-Corp election, so there’s no additional state filing fee. The election is made by filing Form 2553 with the IRS and ensuring your operating agreement allows for the election. The mistake here, aside from not doing this, is missing the election deadline. You have just 75 days after forming the LLC to make the S-Corp election.
3. The Incorporation Overkill: C-Corp When You Don’t Need It
A common mistake for small businesses is becoming a C-Corp to look more like a big business. Seasoned entrepreneurs know better. C-Corps have their place, but they must pay corporate income tax on their profits. That’s 21% federal tax plus 7.9% Wisconsin tax. Owners and shareholders pay additional tax on distributions and dividends. Here’s how that breaks down:
- Corporate level: 21% federal + 7.9% Wisconsin = 28.9% combined rate
- Personal level: Additional tax on dividend distributions
- The total effective rate often exceeds 40%
- Pass-through entities typically face a 25-30% total tax burden
Take a Wisconsin marketing agency generating $150,000 in annual profit. As a C-Corp, they’d pay approximately $43,350 in corporate taxes (28.9% combined rate), leaving $106,650. If the owners distributed $50,000 as dividends, they’d face additional personal taxes on those distributions. The total tax burden could exceed $60,000.
The same business structured as an S-Corp would pay zero entity-level tax, with the $150,000 flowing through to the owners’ personal returns. Even after payroll taxes on reasonable salaries, the total tax burden would be $15,000 to $20,000 less annually.
4. The Timing Disaster: Wrong Tax Year Selection
Selecting the calendar year as your fiscal year seems like the easiest choice for financial planning, but it can be costly. Consider a seasonal business that generates most of its revenue in the fourth quarter. A calendar year-end forces all that income into the current tax year, potentially pushing the owners into higher tax brackets. Other mistakes in this category:
- Missing coordination with personal tax brackets
- Ignoring Wisconsin’s estimated payment requirements
- Poor planning around major income events
The timing of your quarterly tax payments is one reason why this decision is essential. Wisconsin has specific estimated payment requirements that must be coordinated with your chosen tax year. Missing quarterly payments can result in penalties that compound the poor timing choice. That can create cash flow problems that affect business financial planning.
5. The Multi-State Mess: Ignoring Nexus Rules
Wisconsin businesses expanding into Illinois, Minnesota, or Iowa often trigger unnecessary state registrations and tax obligations. These are usually due to nexus rules (tax filing obligations) that govern trade shows, temporary projects, or remote employees. The wrong entity structure can compound this problem. Here are the triggers to watch out for:
- Trade shows in Illinois, Minnesota, or Iowa
- Temporary projects across state lines
- Remote employees in other states
- Physical inventory stored outside Wisconsin
Wisconsin’s throwback rules add another layer of complexity. Sales that can’t be attributed to other states “throw back” to Wisconsin, but only if your entity structure and operations are properly configured. The solution involves analyzing your multi-state activities and choosing an entity structure that minimizes state tax exposure.
Contact Us to Fix These Mistakes
The good news is that D&M Accounting can help you fix business structure mistakes. We’ll begin with a tax projection analysis comparing your current structure to alternatives, then factor in Wisconsin’s tax rates, your business income level, and your personal tax situation. Most of our clients are surprised by the potential savings available through proper structuring.
The implementation timeline matters. Some changes, like S-Corp elections, have strict deadlines. Converting from a sole proprietorship to an LLC can be done at any time, but should be coordinated with Wisconsin’s tax calendar for maximum benefit. Contact D&M Accounting today at 262-253-9955 or visit our website to schedule a consultation.
