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Choosing the best business structure for taxes

On Behalf of | Jul 17, 2024 | Business Planning

Starting a new business involves many decisions. One of the most important choices is the structure of your business. Different structures have different tax implications. Understanding these can help small business owners make informed decisions and avoid surprises at tax time.

Sole proprietorship

With a sole proprietorship, you are the business, and the business is you. You report the income from your business on your personal tax return. So, the profits get taxed at your personal income tax rate. However, this also means you are responsible for self-employment taxes, which cover Social Security and Medicare.

Partnership

In a partnership, two or more people share ownership. Partnerships must file an annual information return to report income, deductions, gains, and losses. However, the business itself does not pay income tax. Instead, each partner reports their share of the partnership’s income on their personal tax return. 

Limited liability company (LLC)

An LLC provides flexibility for your small business. You can choose to have the IRS tax as a sole proprietor, partnership, or corporation. Most small LLCs opt to have the IRS tax them as a pass-through entity, similar to a sole proprietorship or partnership. The difference is that an LLC can provide personal liability protection.

Corporation

Corporations are more complex because they are separate legal entities and pay their own taxes. The IRS taxes income at the corporate rate. If you take profits out of the business, you will also pay taxes on those dividends. This is often referred to as “double taxation.” 

S Corporation

An S Corporation is a special type of corporation that allows profits to pass directly to owners without being subject to corporate tax rates. Similar to a partnership, owners report their share of the profits on their personal tax returns, which can help avoid double taxation. 

Making an informed choice

Selecting the right business structure can significantly impact your tax obligations. Consider the specifics of each option and how they align with your business goals. Making the right choice can save you money and hassle in the long run. 

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