There are countless factors to consider when choosing a business structure for your RIA firm. At the top of the list: tax implications. These vary between each structure, so it’s important to understand them in full. Only then can you make a sound comparison—and choose wisely for your firm.
For RIA firms, we typically recommend a multi-member limited liability company (LLC), partnership, or S corporation. To help you determine which is best for your RIA firm, here’s what you should know about tax implications.
Tax implications of a multi-member LLC or partnership:
Structuring your RIA firm as a multi-member LLC or partnership, such as a limited liability partnership (LLP) or limited partnership (LP), gives you substantial tax advantages as well as flexibility.
Each of these structures allows you to tax-efficiently convert to an S corp, making them a good starting place for your firm. (It’s not as seamless or tax efficient to go from an S corp to a different structure.) As we tell our clients: When in doubt, start with an LLC or partnership.
Additional benefits of an LLC or partnership:
- Allows you to give a key employee ownership in the entity (by issuing a profits interest) without causing an immediate tax to the employee.
- Offers flexibility in succession planning (more tax-efficient than an S corporation).
- Gives you more flexibility in the structure of your RIA firm. The owners don’t have to be individuals—they can also be other entities. This enables you to tax-efficiently bring in non-individual investors.
- Provides complexity and flexibility in ownership structure including distribution and profit allocations.
Tax implications of an S corporation
Because S corps aren’t as flexible as LLCs and partnerships, they’re simpler. The tax rules surrounding S corps are established and straightforward, making the cost of tax preparation less expensive. What’s more, tax planning for an S corp involves less uncertainty.
Additional benefits of an S corporation:
- Although owners of S corps must pay themselves a reasonable compensation, there isn’t a bright line on what is reasonable.
- Flow-through income from an S corp is not subject to self-employment tax, which can provide a 2.9% to 15.3% tax savings when compared to an LLC. However, the Build Back Better Act, if passed, may reduce or eliminate this advantage.
- Offers flexibility to use year-end bonuses to owners to pay for any tax due, allowing you to avoid the administrative hassle and need of quarterly estimated tax payments.
What about C corporations and single-member LLCs?
We often steer RIA firms clear of C corps for two reasons: First, a great deal of uncertainty exists around the future of corporate tax rates. Second, it is expensive and often tax-inefficient to change from a C corp to another structure. In other words, you could be stuck in a tax-inefficient structure because the costs to convert are prohibitive.
Single-member LLCs that are taxed as sole proprietors carry the highest audit risk, so we typically avoid this structure as well.
Which business structure is best for your RIA firm?
Looking at potential tax implications is a great place to start when choosing a structure for your RIA firm. What we’ve covered here is not an exhaustive list—it’s important to do your research and consider other factors as well.
If you’d like to explore business structure options for your RIA firm, we can help. To learn more, contact us today.