Starting a new business comes with lots of exciting and challenging moments. One key decision you must make early on is choosing a tax structure for your new business. It can be tricky; not only are there several to choose from, but each structure has unique financial implications.
This decision can have long-lasting effects on your bottom line, so having a clear understanding of each structure is important.
Below, we’ll walk you through the most popular kinds of tax structures, and when it may be right for you.
Are you starting a new business? Contact an experienced CPA to give yourself peace of mind that your venture will be set up for financial success. Pine & Co. CPAs are here to offer knowledge advice and answer questions you may have. Contact us today.
A sole proprietorship is a business owned and run by an individual with no distinction between the business and you, the owner. Because this tax model is very simple and doesn’t produce a separate business entity, you are entitled to all profits, but are also personally responsible for all your business’s debts, losses, and liabilities. A sole proprietorship is a great way to take full control over your business and be in charge of every aspect from finances to product decisions, but comes with significant responsibility.
A sole proprietorship may be the right tax structure for your business if it’s low-risk and only has one owner. It’s also a good idea for those who want to try out their business before forming a more formal one with a more complicated tax structure.
A partnership is a business structure where there is more than one owner. Partnerships, like sole proprietorships, are simple structures and do not produce a separate business entity. However, this structure is meant for two or more people that are splitting responsibility for the business. There are two common kinds of partnerships: limited partnerships (LP) and limited liability partnerships (LLP).
Typically in a limited partnership, one partner has unlimited liability, while the others have limited liability and control over the company. Profits made in an LP are passed through to personal tax returns, and the partner with unlimited liability also has to pay self-employment taxes. Limited liability partnerships are similar to limited partnerships, but every partner has limited liability instead of just one. An LLP protects each partner from being held responsible for the actions of other partners.
A partnership may be the right tax structure for you if your business has multiple owners. It’s also a good idea for groups that want to give their business a trial run before forming a more formal one, similar to a sole proprietorship.
Limited Liability Company (LLC)
A limited liability company (LLC) combines elements of a partnership, sole proprietorship, and a corporation so the owners of the company have control over their business, but are not personally liable for their business’ debts. This means that personal assets like your home, car, and savings accounts won’t be at risk if your company goes into debt or has to file for bankruptcy. Much like a partnership, profits from your business can get passed through to your personal income without being taxed. However, LLC members are considered self-employed and must pay self-employment taxes.
An LLC may be the right tax structure for you if you want protection for a significant amount of personal assets. If your business involves more risk than a sole proprietorship or partnership, an LLC is a good way to ensure financial safety while also getting the tax benefits of not being a corporation.
A corporation (C corp) is a tax structure that makes your business an entirely separate legal entity. Because corporations offer the most liability protection to business owners, it comes at a higher cost. Some of these costs include investing in good record-keeping and operational processes as well as paying income tax on profits twice a year. However, corporations can sell shares of their company and raise funds to offset these costs.
A corporation may be the right tax structure for you if your business is medium to high risk, and you need quite a bit of liability protection. This structure is also a good choice for businesses that need to raise money or that eventually plan on being sold.
An S corporation (S corp) is almost the same as a C corporation, but is designed to avoid paying income tax twice a year. S corps allow profit to be passed through to the owner’s personal income without being subject to corporate tax rates. In order to become an S corp, the business owner must file with the IRS along with registering with their state. There are also special qualifications your company must meet in order to achieve this status:
- Cannot have more than 100 shareholders
- All shareholders must be U.S. citizens
- Must follow strict filing and operational processes (like a C corp)
An S corp may be the best tax structure for your business if you would file as a C corp, but meet the qualifications to file for the tax advantages of an S corp. Also, make sure your state recognizes S corps and their benefits before deciding on this business structure.
A nonprofit corporation is a tax structure that can receive tax-exempt status because its product or service is free and benefits the public. These are typically formed in order to do charity, religious, or educational work. In order to get tax exemption, the business owner must file a 501(c)(3) form with the IRS and register with their state. The organizational rules of C and S corps apply to nonprofits as well, but these organizations must also be careful about what they do with any profits they earn. Nonprofits are prohibited from distributing money to members of their organization (workers excluded) or donate to any political campaigns.
A nonprofit corporation may be the best tax structure for your business if your work benefits the public and is not used for capital gain. This is also a good structure if you own a church, after school program, charity, or any other organization that doesn’t directly sell a product or service to consumers.
Contact Pine & Co. CPAs
Whether you want to open your first small business or expand your thriving company into something larger, Pine & Co. CPAs offer business consulting and coaching to help you make the right decision regarding your tax structure. Contact us today for a consultation with one of our professionals to get your business started on the right track.