Business Structuring & Tax Implications: Which Business Structure is Right for You?
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One size does not fit it all. No single business structure meets everyone’s business needs. Depending on your current business situation and future aspirations, one business structure might meet your needs better than another. As you are about decide on your new business structure and lay the foundation for your future, now more than ever try to avoid the temptation to do it alone. One error regarding your company’s structure could have serious strategic consequences later on.
There are three basic business organizational structures:
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Sole Proprietorships–the easiest type of business to create. Your business expenses are deductible, all income is taxable to you, and all business liabilities are yours, personally. If you are a self-employed person you really feel the bite of Social Security and Medicare, because you pay both the employee’s share and the employer’s share of the taxes through self employment tax. Most of the small businesses in the United States are sole proprietorships.
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Partnerships – is formed when two or more people decide to enter a for-profit business venture. Each partner owns a portion of the business and is taxed on his or her share of the income, whether or not he or she receives it. There should be a written agreement between you and the partner. In a general partnership, business liability is shared by all the partners. A certain partnership, called a limited partnership, limits the maximum financial liability of the limited partners to their investment.
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Corporations – when you form a corporation, you set up a different organization, distinct from you personally, with a Board of Directors, officers of the corporation, etc. One of the biggest advantages is that if your corporation is sued, you are not generally personally responsible for any damages that might be awarded.
- C corporations. If no special tax election is made, a corporation is a C corporation. With a C corporation you can either leave money in the corporation or pay yourself in the form of a bonus or dividend. If you chose to pay dividends, beware of the costly double taxation issue:
- Dividends are paid to shareholders from the corporate income after the corporate taxes have been paid
- Shareholders pay taxes on the dividends on their personal tax returns
- S Corporations. If you are looking to have the same legal protection as a corporation, yet want the income to avoid the double tax described above, , then the S corporation may be what you are looking for. In an S corporation, the business income is NOT taxed to the corporation, so only one level of tax is paid. The shareholders declare the income on their personal income tax returns. Even if they do not receive any cash. The decision to create an S corporation is heavily based on the how much income you anticipate from your company as well as who is going to own the shares.
- Tax benefits of the S Corporation:
- If you are personally in a lower tax bracket than the corporation, taxing the business income to you decreases the overall taxes paid.
- If the corporation loses money, you may be able to use that loss to offset personal income earned from other investments.
- However, if the company does better than expected, then you may end up with a huge tax bill at the end of the year.
- Limited Liability Company (LLC). LLCs provide business owners with personal liability protection while taxing profits at the individual level only, similar to a subchapter S corporation. LLCs will also allow you to avoid double taxation. An LLC owned by one person is generally treated like a sole proprietorship for tax purposes while an LLC owned by more than one person is usually taxed like a partnership. One advantage of an LLC is flexibility of how profits are divided. When setting up your LLC you must be careful to follow the LLC rules in your state.
- Franchises. Technically, franchises are not a business structure, but it is a way to start a business, using the proven success formula of an existing company. When you purchase a franchise, you need to go through the same planning as starting a new business, including what form of business structure will best meet your needs.
Keep in mind:
If you do business in different states, you may need to perform filing and registrations so you do business legally in those states and pay sales taxes accordingly on revenues generated from operations in those states.
The Government and many large businesses have “set-aside” contracts for certain business categories. We are listing some of those business categories certifications below. If your for-profit business holds any of these certifications, you can drastically increase your chances of winning a contract. Some of the certifications include:
Taxes never go away and they are a part of your business. But you can try to minimize their impact on your profits. How much will the taxes impact your business depends on the business structure you chose based on your strategic goals. Each form of business structure has its own benefits. Which one will best meet your needs?