Starting a business comes with many decisions, and one of the most critical is choosing the right business structure. The entity you select affects not only your legal liability and operational flexibility but also your tax obligations. To help you make an informed choice, here’s a breakdown of the most common business structures and their tax advantages.

Sole Proprietorship

A sole proprietorship is the simplest business structure. It’s easy to set up and requires minimal paperwork. However, it does not provide liability protection, meaning the business owner is personally responsible for debts and obligations.

Tax Benefits:

• Income is reported on the owner’s personal tax return (Form 1040, Schedule C), simplifying tax filing.     
• No corporate taxes; profits are subject only to individual income tax rates.
• Business losses can offset other personal income, reducing overall tax liability.

Partnership

A partnership is formed when two or more people share ownership of a business. It can be a general partnership (GP) or a limited partnership (LP), where some partners have limited liability.

Tax Benefits:

• Pass-through taxation: Profits and losses flow through to the partners’ personal tax returns, avoiding double taxation.
• Flexibility in income distribution: Partners can agree to distribute profits in a way that maximizes tax benefits.
• Deductible business expenses, including startup costs and operational expenses, reduce taxable income.

Limited Liability Company (LLC)

An LLC is a popular structure that combines the liability protection of a corporation with the tax flexibility of a partnership.

Tax Benefits:

• Pass-through taxation by default (similar to a sole proprietorship or partnership), meaning no corporate tax.
• Option to be taxed as an S-corp or C-corp, allowing flexibility in tax planning.
• Owners can deduct business losses from personal income, subject to IRS restrictions.
• Self-employment tax savings: LLCs electing S-corp taxation can pay themselves a reasonable salary and take additional profits as distributions, which are not subject to self-employment tax.

S Corporation (S-Corp)

An S-corp is a corporation that elects to pass income, losses, deductions, and credits through to shareholders for tax purposes.

Tax Benefits:

• Avoids double taxation: Business profits are not taxed at the corporate level but flow through to shareholders’ personal tax returns.
• Shareholders can receive both salaries and dividends, reducing self-employment tax obligations.
• Business losses can offset personal income, subject to IRS passive activity loss rules.
• Eligible for the Qualified Business Income (QBI) deduction of up to 20% on pass-through income.

C Corporation (C-Corp)

A C-corp is a separate legal entity that pays corporate taxes and can have unlimited shareholders.

Tax Benefits:

• Corporate tax rate (currently 21%) may be lower than individual income tax rates for high earners.
• Business expenses, including employee benefits and reinvested profits, are deductible.
• No self-employment tax on dividends paid to shareholders (but subject to double taxation).
• Easier to raise capital through stock issuance.

Choosing the Right Entity for Your Business

When deciding on the best entity for tax purposes, consider the following:

• Liability protection: Do you need to separate personal and business liabilities?
• Tax efficiency: Which structure minimizes your tax burden based on income and deductions?
• Growth plans: Will you seek investors or plan to reinvest profits?
• Administrative complexity: Are you willing to handle the paperwork and compliance requirements of corporations?

Final Thoughts

Choosing the right business entity is crucial for optimizing tax benefits and protecting your business. Since tax laws are complex and frequently change, consulting with an accountant or tax advisor can help you select the best structure for your specific situation. Whether you’re starting a new business or considering a restructuring, making an informed decision now can save you money in the long run.

Need help deciding which entity is right for you? Contact our accounting team today for expert guidance!