If you're a business owner, it's critical to review your entity election regularly to ensure it's still serving you from a tax perspective. Whether you're a new business owner or you've been around for years, there is always a chance that you might need to make a change. Evaluate often enough that you don't disadvantage your business.
There are 5 main types of business structures to choose from: sole proprietorship without an LLC, partnership, corporation, S corporation, and limited liability company (LLC).
Sole proprietorships are owned and operated by one person. The owner is personally liable for all debts and losses if not protected through an LLC structure. Taxation is pass-through.
Partnerships involve two or more co-owners running the business together. Taxation is pass-through. Different types include general, limited, LLP, and LLC partnerships.
C Corporations are separate legal entities from their owners. They have the strongest liability protection but are subject to double taxation. Extensive recordkeeping is required.
S corporations are a special type of corporation that avoids double taxation through pass-through taxation. Owners aren't personally liable for losses.
LLCs combine aspects of partnerships, sole proprietorships and corporations. Taxation is generally pass-through. Owners have limited liability protection.
Entity structure is important when considering costs, control, compliance, and protection of owners from a liability perspective, but it is also something you need to consider from a tax perspective. If you need help determining which entity structure is best for you, or if you're wondering if your current entity structure is still serving you well from a tax perspective, it's important to talk to a tax professional.
Here are a few things to consider when evaluating your entity structure for tax purposes:
- Pass-through vs. taxable entities. Pass-through entities, such as sole proprietorships, partnerships, and LLCs, are taxed at the individual level. This means the business does not pay taxes, but the owners do. Taxable entities, such as C corporations, are taxed at both the business and individual levels.
- Income tax rates. Pass-through entities are only taxed at the individual owner's income tax rate, which vary depending on your income bracket. C corporations pay a flat tax rate of 21%. Individuals pay income tax on the dividends they receive at a rate of generally between 15-20% depending on their tax bracket.
- Self-employment taxes. Self-employment taxes are social security and Medicare taxes that employees and their employers must pay. Self-employed individuals have to pay both components of that tax on their profit. Specifically, entities that pay their income taxes using a Schedule C and partners of partnerships have to pay self-employment taxes on their business income. S and C Corporation business owners do not pay self-employment taxes on the business profit above their wages.
If you're not sure which entity structure is correct for you, or if you're wondering if your current entity structure is still serving you well from a tax perspective, contact us today!