You are ready to start your own business. Congratulations! And welcome to a whole new world of legal decisions that are now your responsibility. After tackling the more fun items like business name and logo, the first and foremost legal decision is selecting the form of business entity you wish to establish.
Did you know there are five possible business structures that pertain to self-employment? Each one comes with its own parameters and qualifications, as well as tax liabilities. In this blog, we will walk through the key structures, so you can assess which ones you may want to research further to select the best option.
Business Structure Specifics
There are five business structures that apply to the self-employed, and each has its benefits. Before getting into those specifics, here’s a brief overview from the U.S. Small Business Administration to familiarize yourself with each business structure.
Sole Proprietorship
This easy-to-form business gives you complete control. There is no separate business entity, so your business assets and liabilities are connected to your personal assets and liabilities. This means you can be held liable for all business debts and obligations.
Partnership
A partnership is a business owned by two or more people. They come in two forms. A Limited Partnership (LP) has one person named as the general partner with all liability, whereas the members of a Limited Liability Partnership (LLP) all share the liability.
Limited Liability Company (LLC)
The LLC is a common business structure because it protects your personal assets from bankruptcy or lawsuits your business may encounter. If membership in the LLC changes, some states may require the LLC to dissolve and re-form.
C Corporation
A C Corp is a legal entity separate from its owners that can make a profit, be taxed, and can be held legally liable. For the most protection from personal liability, corporations are the best bet. However, they are the most expensive to form and require extensive record-keeping.
S Corporation
An S Corp is designed to avoid double taxation like traditional corporations because profits and some losses are allowed to pass through directly to the owner’s personal income without being subject to corporate tax rates. A separate filing with the IRS is required to acquire an S Corp status.
Key Tax Considerations of Each Structure
Now that you are aware of the basics of each business entity, look at how some of these structures affect tax liability.
- Tax flexibility: LLCs and corporations offer more flexibility than sole proprietorships and partnerships. So, with careful tax planning, LLCs and corporations allow more significant potential tax savings.
- Self-employment tax: Sole proprietors, partners, and S corporation shareholders pay self-employment taxes, while C corporation shareholders don’t. Understanding what self-employment tax is and its impact on overall tax liability is essential.
- Pass-through entities: LLCs, partnerships, and S corporations that are known as “pass-through” entities. That means the income generated by the business “passes through” the entity and is directly reported on the individual owners’ or shareholders’ personal tax returns. The main advantage of a pass-through entity is that they avoid double taxation because the business doesn’t pay income taxes on the entity level.
- Qualified Business Income (QBI): LLCs, partnerships, and S corporations also can benefit from the QBI deduction, offering potential deductions of up to 20% of qualified business income.
- State laws: Depending on your state, certain business structures might be subject to additional fees or franchise taxes, affecting your bottom line and thus taxes.
You may feel comfortable making many business decisions on your own, but it’s always advisable to seek professional counsel when initially starting a business. It’s the job of a licensed professional to assess potential impact on your personal and business finances depending on the chosen business structure.
Get Expert Advice from KPN
As business owners ourselves, we understand what you are going through. We encourage you to contact us, the experts at KPN as you establish your business. We can answer your questions and will collaborate with you to ensure your tax liability and business financial plan are in tune.