Top 5 tax consequences of breaking away

Top 5 tax consequences of breaking away | Elevate CPA Group

“Look before you leap” is a good adage to remember if you’re breaking away to start an independent RIA. It’s easy to get caught up in the flurry of launching a new firm. But when this happens, you risk forging ahead without the necessary forethought.

One thing to look into before you begin the breakaway process? Your tax situation. Owning an independent RIA firm will undoubtedly put you on the hook for additional taxes. This shouldn’t be a deterrent to starting your own firm; however, it’s important to know what you’re getting into.

To give you an idea of what to expect, here are the top five tax consequences of breaking away.

You could owe taxes even if you don’t take a paycheck.

If you structure your new RIA firm as an LLC or S corporation (which most RIA firm owners do) you’ll be taxed on the entity’s net income and not on your just your salary or bonus. This is true even if you don’t take a paycheck. Generally speaking, your tax bill will be your firm’s net income divided by your percentage of ownership.

You’ll likely need to make estimated tax payments.

Once you become a firm owner, your income will no longer be subject to tax withholding. This means you’ll have to make estimated tax payments four times a year (once each quarter). These should add up to 90% of the current year’s estimated taxes or 110% of the previous year’s taxes due.

You could be responsible for self-employment taxes.

As an employee, your employer withholds your Social Security and Medicare taxes and matches these amounts as payroll tax. If you structure your independent RIA firm as an LLC, you’ll be subject to the employer and employee portions of this tax. However, S corps can help decrease this burden—something to consider when choosing your entity type.

Your firm’s structure will affect your taxes.

As you can see, your RIA firm’s entity type will impact the taxes you owe. Other aspects of your firm’s structure will affect your tax liability, too. These include your ownership percentage and the amount you’re paid, as well as the benefits you provide to owners and who pays for them. Your compensation equivalent matters, too.

You can’t let your books and records lapse.

Up-to-date and accurate books and records are critical to your independent RIA firm’s success. Knowing your firm’s financial health at any given time gives you the ability to plan.

What’s more, when it’s time to do your taxes, you will no longer be simply handing your accountant a W-2. Instead, you’ll be handing over your firm’s books and records. Having these in order will prevent delays.

Don’t let taxes get in the way.

The tax consequences I’ve mentioned here are just a few of the things to consider when breaking away to set up an independent RIA. Also, these consequences apply to federal taxes only—each state’s tax rules are slightly different!

As you plan for tax consequences that could impact you, we’re here to guide you through the process. Elevate’s Independence Alliance provides the expertise and resources to go from thinking about becoming an independent RIA to thriving. In other words, we help you stay focused on your new business—and worry less about your taxes.

Ready to learn more? Contact us today.