Selecting or changing your business’ legal entity is an important financial decision. Each type of business structure brings it’s own set of tax liabilities and legal consequences. Before making any decisions, new business owners should take the time to thoroughly research all the differences between the most common business entities. It might even be a good idea to consult with an accountant or lawyer if you really want to ensure the most beneficial decision. Unfortunately, finding information on the tax laws surrounding each separate entities can be difficult, therefore we have compiled the following list detailing the tax consequences for each one.
1. Sole Proprietors
With a sole proprietorship, there is no distinction between the person who owns the business and the business itself. Because of this, the sole proprietor is liable for any legal disputes against the business, as well as all tax liabilities. Specifically, the business owner is liable for income and self-employment taxes on all business profits. There are numerous disadvantages of sole proprietorships but one advantage is that an owner can hire their children and not have to pay payroll taxes. Sole proprietors also have the advantage of not being charged a penalty should they dissolve the business.
2. General Partnership
A general partnership is pretty similar to a sole proprietorship, however the liability is spread between multiple taxpayers, instead of just one person. While both sole proprietorships and general partnership give you more tax flexibility, it comes at the expense of also being more liable both legally and financially.
3. Limited Liability Companies (LLCs)
A great advantage of an LLC is the benefit of no double taxation. You also receive more flexible tax options. An LLC owner can choose between having the business taxed separately as its own entity, or decide to have the taxes pass down like with a partnership or sole proprietorship. This flexibility and added insurance has made LLCs a good option for many business owners in this country.
4. Corporation
If you choose to incorporate your business, the corporation will be taxed at it's own corporate tax rate. While sole proprietors see flow-through income, C-corporations, encounter “double taxation.” Meaning the corporation is taxed for the income it earns, then, the individual shareholder is also taxed on their income. However, C-corporations do get to enjoy a wide range of tax deductions for business losses and fringe benefits.
5. S-Corporation
In addition to C-corporations, the IRS also recognizes what is known as an S-Corporation. You can make the change simply by filing Form 2553 with the IRS. As opposed to C-corporations, an S-corporation is not taxed separately, but more like a partnership or sole proprietorship would be. Therefore the biggest benefit is that S-corporation owners can avoid being double taxed on their income.
Other Considerations: State Taxes
There may be specific state liabilities for some business entities, depending on where you live. These taxes can often sway you one way or the other if you are having trouble deciding. Always make sure to check out your state tax board for information on business taxes before you make any decisions.