Starting a small business can be an exciting time, and business owners do not always take the time in the beginning to determine what sort of small business structure is best suited to their financial and organizational needs. It can be well worth the effort to examine the various structures and see whether your tax position could be improved with a different setup for your small business.
Of all the types of structures, a sole proprietorship is the easiest to create and manage. It also offers tax benefits, such as passing profits and losses from the business to the owner’s personal tax return. This means business income is not taxed twice, which can be an issue with other structures. A sole proprietorship has other limitations, but its tax profile should not be a cause for concern.
Another fairly simple small business structure is a general partnership, which can operate similarly to a sole proprietorship in terms of taxation. In addition to passing profits and losses to the partners who own the business, a general partnership files a Form 1065 with the IRS to document business income. However, this form is purely informational, and a general partnership does not pay taxes. Again, while there may be other reasons not to consider forming a general partnership, the tax aspects of this structure are not at issue.
On the other hand, forming a corporation can open your business up to double taxation. A C corporation is taxed at the business level, and dividend income paid to shareholders, such as the corporation’s owners, is also taxed. An S corporation offers the same tax advantages of a general partnership, in that profits and losses are passed to the owners and taxed only once. While this is helpful in terms of taxes paid, bear in mind that corporations have more stringent regulations and tax requirements as compared to partnerships.
A Limited Liability Company (or LLC) is a small business structure that can combine the advantages of both partnerships and S corporations. However, LLC members pay self-employment taxes on all business income, whereas S corporations pay self-employment taxes only on salaries paid out. Tax aspects of LLCs also vary according to the states where they operate, so it is possible that an LLC may not be the most advantageous structure in the state where you live.
After reviewing the tax treatment of each of these structures, it is possible that your organization could benefit from a change to its small business structure. It can be a smart business decision to speak with an attorney or accountant to discuss your situation and determine your best course of action.