Choosing The Right Business Entity Tax Structure

Establishing The Correct Legal Business Structure For Tax Purposes Will Save You Thousands

In the years I have been in business I can not tell you how many people have chosen the wrong entity structure for their size or growth rate. Not to mention how many people have been suckered into changing their entity structure by a CPA, lawyer, or accounting firm who had no idea what was actually best for the company or owner. I struggled with this in my own business, trying to figure out what model or type of incorporation gave me enough protection as well as the best tax situation for the amount of income we were generating.

Choosing wrong can be the quickest way to increase costs and fines and also increase the complexity of your business beyond your ability to handle it. Below are the different types of entities and their tax benefits. 

• Sole Proprietor- This type of entity is the most common and is desirable in situations where there is little to no personal liability. Legally this means the business and the owner are the same entity. Some of the key advantages are: easy set up, some states may not require you to register, profits are taxed on the personal income tax return, the owner has complete control, and assets are easy to liquidate should anything happen to the owner. The biggest downfall to this structure is that the owner is open and responsible for all legal liability in the event of a lawsuit.
• Single Member LLC-The Limited Liability Company is the favorite for most small businesses. It is fairly easy to set up, but articles of incorporation must be filed in the state where it resides, this is called domicile. It offers much more protection from legal liability that the sole proprietorship offers, and you can choose how the company will be taxed either as an S-Corp, or as a LLC filing on Schedule C with your personal tax return. Unlike the C-Corp you do not need a board of directors, but you can have unlimited number of members. However that will cause you to become a multi-member LLC. The biggest draw back here is the increased accounting and tax costs as it grows. 
• Multi-Member LLC- this is an LLC or Limited Liability Company that is taxed like a partnership. This allows you to avoid double taxation, I.e. no self-employment tax. You can also have distributions and allocations that are disproportionate to the level of ownership. The biggest draw back is the inconsistent treatment of this type of entity from state to state.
• Partnership- This is a entity structure similar to an sole proprietor except you can have more than one owner. It is still very easy to form this type of entity, and there are some tax benefits when incorporating family and children into the mix. Taxes become a little more complicated but not by much. The biggest downside is that when dealing with two equal partners its likely you will not always agree. 
• S-Corporation-An LLC can elect to be taxed as this type of entity structure, the owners then have limited liability for the operations of the company and it can be perpetual and live long past those who originally started the company. Any profits that pass through to the owners are exempt from self-employment tax, and FICA taxes. You have the ability to issue stock to raise capital for the business. Unfortunately there are struct reporting guidelines and requirements. All profits need to be liquidated from the company at the end of the year by the owners and then re-injected back into the company at the beginning of the fiscal year to create additional basis for the owners. The biggest draw back is the complexity of the reporting, tax requirements, and remembering to keep track of your basis as the owners so you know how that will affect spending and tax free distributions. 
• C-Corporation- The C-Corp is a legal entity completely separate from its shareholders or owner. The entity itself can create and execute contracts and sell or buy property and assets. The C-Corp is the most complicated business structure there is after the S-Corp. You need to set up a board of directors, which can consist of just the owner, you have to record minutes at meetings even if it is just yourself. You can sell shares and stock in the business to raise capital and you have a very complicated tax return structure and process, where many things need to be reported to the government. This is where the majority of CPA’s are actually trained to spend their time. The C-Corp also has more access to capital options than the other forms of entity structure. The biggest draw back to this type of entity is the legal set up required and additional accounting costs, and that you can still sometimes get hit with double taxation. 

Now that you have a breakdown of what each of the structures are and do, I hope when faced with the situation of setting up your company you can make the qualified choice. At Rood Financial we thoroughly interview our Start-up clients for more than just one meeting or an hour before advising them on how to set up their company.  This is a must and if someone says after meeting you for 30 mins that they can set up your company in this way or that way and it will save you the most money, I would question it. Please don’t just take our word for it do your own research, this is not a choice that should be made lightly.