Launching a new business is no simple feat. It’s a detailed process that requires you to make many key decisions — with one of the more 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 that 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 you make an informed 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 to set up a corporation. An LLC can be taxed as a sole proprietor, partnership, S corporation or C corporation. Making the choice to form your business as an LLC still leaves the decision of which tax structure to pair it with.
Sole proprietorships are the easiest and least expensive structure to set up, and there are few formalities to maintain. There’s no separate income tax filing required, as 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 your business has two or more owners. This structure has similar pros and cons to a sole proprietorship. Partnerships can be flexible to fit your operating needs, but they can add a layer of complexity to 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 returns. There are two types of partnerships to consider: general and limited.
General partnerships are typically formed using a written agreement between owners. They don’t require filling out paperwork within the state in which the owners reside and offer no liability protection. In general partnerships, owners file taxes under their respective names.
Limited partnerships are made up of one general partner and other limited partners. The general partner has unlimited liability, is more involved in the daily operations of the business and is accountable for paying self-employment taxes on the partnership’s profits. Limited partners are what they sound like — limited in their liability and in their involvement within the business.
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 returns. The self-employment tax in an S corporation is limited to owner compensation paid through payroll (rather than being 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 don’t 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 double taxation. This means a C corporation must pay income tax at a flat rate of 21% on its profits and that shareholders are also taxed on their distributed 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 activity types, 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’s also important to keep in mind that your choice of tax structure shouldn’t be driven solely by tax considerations. There are many other factors to consider, and you’ll want to include legal advice in the decision.
If you have additional questions on which tax structure aligns best with your business, Creative Planning can help. Contact us today to learn more about our tax services and what they can do for your business.