Cracking the Code of Legal Structures

Are you considering starting a new business? How about looking to maximize tax savings in your current business? Whether you are a new entrepreneur taking the leap of faith or an established business owner, it’s important that you choose a business structure that maximizes your tax savings. 

Let’s dive into a few common business structures and their tax implications, giving you the information needed to choose the right structure for your business. 

Sole Proprietor/Single-Member LLC

The first and simplest business structure is a sole proprietorship and single-member LLC. All income or loss is reported directly on the individual tax return on Schedule C. Sole proprietorships report income on a cash basis, only recording transactions when cash is received or leaves your bank account. This can result in a favorable tax situation depending on the timing of income. 

However, you will pay self-employment taxes on the net income reported, which is your income minus your expenses. In addition, ordinary income taxes will also be assessed based on net income. There are credits and deductions that can offset these taxes, like the Qualified Business Income Deduction. Nevertheless, many small businesses gravitate towards this structure because of its simplicity. 

Partnership/Multi-Member LLC

Moving up the complexity scale is a partnership and multi-member LLC. Unlike sole proprietorships, partnerships and multi-member LLCs are required to file a separate business return because there might be more than one owner. Income is still reported and paid on the individual return on Schedule E. 

Income may be subject to self-employment taxes, and other taxes at the business level, such as franchise fees. Also, self-employment taxes may be assessed on guaranteed payments from the partnership or multi-member LLC. Regardless of if guaranteed payments are made, you will still need to pay ordinary income taxes on the pass-through income. 

Corporations

There are two types of corporations: S-corporations and C-corporations. S-corporations are treated similarly to partnerships, with income and loss flowing through Schedule K-1 and being reported on Schedule E of the individual tax return. 

Unlike S-corporations, C-corporations report and pay all taxes at the business level. This results in no income or loss being reported on your individual tax return. Currently, federal taxes are assessed at a rate of 21%, with state tax rates varying. Depending on your tax bracket, this can result in tax savings, with the top individual tax bracket reaching 37%. No self-employment taxes are paid on this income, but you may need to report taxable income if the corporation pays out dividends. 

Choosing the Right One

Choosing the right business structure can seem like an overwhelming decision. If you are just starting out and don’t expect to make much profit, a sole proprietorship structure might be right for you. On the contrary, if you are expecting to see rapid growth and want to bring on multiple partners, a partnership, multi-member LLC, or S-corporation might work best. 

These are just a few of the common business structures that your business may need to choose between. However, there are other structures, like trusts, non-profits, and limited partnerships that may fit your situation. This makes it important to work with an expert that can help you navigate the tax pros and cons of each structure, ensuring you are minimizing your tax liability. 

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