How Your Business Structure Impacts Your Bottom Line

Choosing the proper business structure is a crucial decision for any entrepreneur. It affects everything from liability protection to how you raise capital. And another critical factor to consider is taxes.

The way your business is structured determines how you’ll be taxed. Here’s a basic overview of the tax implications of the most common business entities in the US.

Business Structures and Taxes

Sole Proprietorship: This is the simplest structure, where you and your business are legally one. All business income and losses pass through to your personal tax return and are taxed at your individual income tax rate. There’s no separate tax filing for the business itself. However, you’re responsible for paying self-employment and regular income taxes.

Partnership: Similar to a sole proprietorship, partnerships don’t pay taxes. Profits and losses “pass through” to the partners’ individual tax returns according to their ownership percentages. Partners are also liable for self-employment taxes.

Limited Liability Company (LLC): LLCs offer flexibility in taxation. By default, they are treated like partnerships, with profits and losses passed through to the members’ tax returns. However, LLCs can be taxed as corporations, which we’ll discuss next.

Corporations: Corporations are separate legal entities from their owners (shareholders) and pay corporate income tax on their profits. When profits are distributed to shareholders as dividends, those dividends are taxed again at the individual level—known as “double taxation.”

S Corporation (S Corp): S corporations are a particular type of corporation that avoids double taxation. They elect to pass corporate income, losses, deductions, and credits directly through to their shareholders for federal tax purposes. Shareholders then report this flow-through income and losses on their personal tax returns, which are taxed at their individual income tax rates. 

The S Corp election offers a tax advantage for businesses with high profits and owner-employees who want to avoid self-employment taxes. However, there are limitations to S corp eligibility, such as having a maximum of 100 shareholders who must be US citizens or permanent residents.

Choosing the Right Structure

There’s no one-size-fits-all answer when it comes to business structures and taxes. The best choice for you depends on several factors, including:

Business size and income: For small businesses, the simplicity of a sole proprietorship or partnership might be appealing. However, as your business grows, the tax advantages of a corporation might become more attractive.

Liability protection: Corporations and LLCs offer limited liability protection, meaning your personal assets are generally shielded from business debts—a significant advantage for businesses with higher risks.

Ownership structure: A partnership or LLC might be a better fit than a corporation if you have multiple owners with different tax situations.

If you need help choosing the best structure for your business, check out our easy-to-use Business Structure Wizard. The whole process takes less than five minutes.

Remember, this is just a basic overview. Consulting with a tax advisor is essential to determining your business’s best structure. For more information on business structures, visit our website CorpNet. And when you’re ready for help registering your company in your state, the experts at CorpNet are standing by. 

Photo courtesy: White puzzle with word Business & Tax by wuestenigel is licensed under CC BY 2.0