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How Your Business Structure Impacts Your Taxes

By on January 13, 2023 4 min read
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How Your Business Structure Impacts Your Taxes

Did you know that the way you structure your business can have an impact on your taxes? That's right - the type of business entity you choose can affect how much tax you pay.

So, if you're a small business owner, it's important to understand the different types of business entities and how they are taxed. In this guide, we'll look at five common types of business structures and explain how each is taxed.

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What are the Different Business Structures?

There are several different business structures to choose from, and each of them includes specific tax obligations. Many small businesses opt for a limited liability company (LLC), allowing the owner to have limited personal liability protection while providing their business with a simpler tax treatment than a regular corporation, but let's compare your options.

Limited Liability Company (LLC)

An LLC is a business structure that offers the owner personal and financial protection. The types of services that can be offered by an LLC are wide-reaching and include activities such as eCommerce, consulting, and product development.

Sole Proprietorship

A sole proprietor is an individual business owner who, unlike a corporation or partnership, does not have to register with the government, making it one of the least complicated forms of business structure. This allows the proprietor complete operational control over the venture and easy access to profits or losses incurred.

Related Reading: LLC vs. Sole Proprietorship. Which is Right for my Business?

Corporation

A corporation (C-corporation) business structure is advantageous for companies that want to protect their founders and shareholders from personal liability for actions taken with regard to the business. A corporation can serve all types of businesses, from small startups to large multinational enterprises. It also helps to limit risk - because the owners' financial responsibility is limited, they can't lose more than what has already been invested in the company.

S-Corporation

An S-corporation is an entity that is taxed differently from a regular or C-corporations. This type of corporation allows a business to face pass-through taxation, which means that the sole proprietor, partners, or shareholders are treated as having ownership over their respective income made by the company.

Partnership

A partnership business structure is a fantastic way to bring together the strengths of two or more people in a mutually beneficial agreement. Each partner can benefit from tax savings, shared knowledge, and potential growth opportunities.

When forming a partnership, it is important to have a clearly established agreement with outlined roles, responsibilities, profit and loss administration, and dispute resolution. Partners in a partnership business structure are legally held accountable for all business activities, and each partner has full responsibility for any debts that may be incurred. While this legal relationship does provide some risk, there can be potential benefits, such as increased financial support, shared ideas, abilities, etc.

It’s best to consult with a professional accountant or financial advisor to help you determine the best approach for your business from an organizational and taxation perspective. It’s also wise to review state and local regulations, as these may vary significantly when deciding on the optimal legal structure for your business.

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What are the Tax Implications for Each Business Structure?

One of the most important factors to consider when starting a business is the type of structure you choose. Your choice of structure can have a significant impact on your taxes. Let's dive into some of the tax implications for each business structure.

LLC

LLCs can be taxed in multiple ways. Depending on the elections that the business owner selected, the IRS can treat an LLC as either a corporation or partnership or as part of the LLC’s owner’s tax return. If no elections are selected, LLCs, by default, are taxed to the single owner, similar to that of a Sole Proprietor.

Corporation

Corporations are taxed at the corporate level and personal levels. They are taxed twice because they are first subject to corporate income tax on their profits, which is then passed onto shareholders when distributed as dividends. In addition to this, shareholders also have to pay tax on their dividend earnings, leading to double taxation.

S-Corporation

S-corps pass profits and losses through to the shareholders, which then pay taxes on them as part of their personal returns. S-Corporation status is a tax designation granted by the IRS that lets corporations pass their income through to their shareholders.

This offers benefits such as avoiding double taxation and taxes on preferential stock dividends, resulting in less tax liability than traditional Corporations. S-corporations also provide additional flexibility to the shareholders regarding control over deductions, corporate income, and ownership changes.

Sole Proprietor

As a sole proprietor, your business income is directly reflected in the taxes you pay as an individual. You don't have to worry about paying additional tax on company earnings; instead, they will be incorporated into your personal tax federal rate.

Partnership

Business partnerships are taxed as "pass-through" entities, meaning any income generated by the business is passed directly to each owner’s personal income tax return. Instead of a W-2 for employees, partnerships use Schedules K-1 (Form 1065) so each partner can reflect profits and losses on their personal returns without any hassle come filing season.

When it comes to taxation, using the right entity for business formation can save an incredible amount of money over time - potentially saving thousands, if not hundreds of thousands of dollars in taxes throughout the life of your business. So take some time to evaluate all your options, so you can get the best possible outcome in terms of positioning yourself for lower expenses and maximum profitability.

How to Choose the Right Business Structure for Your Company

Choosing the right business structure for your company doesn't have to be overwhelming. It's important to consider your individual preferences and goals and your industry needs when determining the most suitable structure for you and your business.

Start by researching all of the above options so that you can make an informed choice. Once you have narrowed down your selection, consider consulting with other business owners who have experience in this area or with a professional. An expert's guidance can help clarify which business structure will work best for you and provide peace of mind that any choice is being made with confidence.

Form Your Business Structure with Incfile

Out of all of the options, each structure has its own unique benefits and drawbacks, and understanding them thoroughly is paramount before making a final decision.

We are partnering with Incfile so you can easily set up your business structure! They make incorporating a company as easy as possible so that you can focus on the important things. Beyond free LLC filing, they have a full suite of startup services (like banking and bookkeeping), which means Incfile helps you get started and supports your continued success as your one-stop shop.

Whether you’re starting an LLC, S-Corp, C-Corp, or other business entity, their mission is to provide you with a superior and modern experience at an unparalleled value. Get started today.

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