When you start a new business, you have to take many choices into consideration. Each decision you make will take into account the type of business you plan to run and how you plan to run it. As you plan your new business structure, one major decision will be which type of business entity you want to create.
Each type of business entity offers different tax benefits. Understanding how your business runs will help you understand which tax structure benefits you the most.
Sole proprietorship or partnership: Pass-through taxation
A sole proprietorship is a simple business with one owner. With a sole proprietorship, the business owner pays all business taxes as part of his or her personal taxes. This is known as pass-through taxation. If you have a small business that doesn’t make a lot of money, a sole proprietorship can help you take advantage of pass-through deductions.
A partnership is similar to a sole proprietorship in that the owners pay pass-through taxes. All owners of a partnership are responsible for taxes. There are different options in types of partnerships, but all of them have pass-through taxation.
Limited liability company: Flexibility in taxation
With a limited liability company (LLC), an owner has more choice in taxation. An LLC owner can take advantage of pass-through taxation. However, if the business would receive more tax benefits as a corporation, an LLC owner has the option to file taxes as a corporation. This flexibility helps LLC owners get the best tax benefits possible.
Corporations: C-corp versus S-corp
If you set up a corporation, you have an option to set up a C-corporation or an S-corporation. A C-corporation, also known as a C-corp, is a traditional corporation. The IRS taxes the corporate entity independently of the shareholders. Depending on the size of the company, a C-corp can offer many tax benefits.
With an S-corporation, or S-corp, the shareholders can choose pass-through taxation. Like a C-corp, the company becomes a traditional corporation. But instead of the corporate entity getting taxed, shareholders pay the business taxes on their personal tax returns.
These are just a few of the most common business entities you have as an option. You will want to meet with an accountant and a tax lawyer to make sure that you choose the right one for your business.