Launching a small business is no simple feat. It’s a detailed process that requires you to make a lot of key decisions. One of the most important determinations being which tax structure you want your business to fall under. Each tax structure has its own set of tax and non-tax pros and cons which must be considered along with your own goals and personal situation. Not sure which tax structure makes the most sense for your future business? Here’s a breakdown of several types of business tax structures to help with that decision.
Limited Liability Company (LLC)
LLCs have become increasingly common, particularly for startup companies. In general, it can be easier and less expensive to set up an LLC than it is to set up a corporation. An LLC can be taxed as a sole proprietor, partnership, S corporation or even a C corporation. Making the choice to form your business as an LLC, still leaves the decision for a tax structure to go with it.
Sole proprietorships are the easiest and most inexpensive structure to set up and there are few formalities to maintain. There is no separate income tax filing required, the business activity is included within the owner’s personal income tax return. All profits from a trade or business activity will be subject to self-employment tax. The largest drawback for a sole proprietor is the lack of liability protection.
You may consider using a partnership structure if you have two or more owners. They have similar pros and cons to a sole proprietorship. There are two types of partnerships to consider, general and limited. Partnership agreements can be flexible to fit your operating needs, but this does add a layer of complexity to the tax return preparation. Partnerships have an income tax return filing requirement, however, the profits or losses pass through to the owners and are included on their personal income tax return. Partnerships are a good option for holding real property held for investment or as a rental activity.
S corporations provide a solid structure for many small businesses. S corporations have an income tax return filing requirement, however, the profits or losses pass through to the owners and are included on their personal income tax return. The self-employment tax in an S corporation is limited to the owner compensation paid through payroll, rather than applied to all profits of the business. S Corporations are limited to a maximum of 100 shareholders. Partnerships, other corporations, certain kinds of trusts, and nonresident aliens do not qualify as eligible shareholders.
C corporations are commonly known as regular corporations. This is the only tax structure that pays its own tax but is subject to a double system of taxation. That means that their profits are subject to income tax at a flat rate of 21% and they are also taxed to the shareholders if distributed as dividends. Although the taxation may seem high, many times it can be minimized when corporations put their profits back into their business to fuel future growth.
Deciding which tax structure aligns best with your unique business needs may seem complicated, but it doesn’t have to be. By evaluating your business goals and types of activities, you can feel confident selecting a tax structure that’s beneficial to you and your tax strategy. Partnering with a tax professional to assist you in your business planning is a terrific way to ensure your start-up questions are answered, and the right decisions are made so that you can focus on making your small business dreams a reality. It is also important to keep in mind that a choice of entity decision is not driven solely by tax considerations. There are many factors to consider, and you will want to include legal advice in the decision.
If you have additional questions on which tax structure aligns best for your small business, BerganKDV can help. Contact us today and one of our tax professionals will assist you.