Wondering how taxes fit into your consideration when selecting the best legal entity for your business? When a new business is created, there are so many aspects to consider that taxes may be the last thing on your mind. However, setting up your entity to be taxed in a way that advances your goals is an important part of your success.
Here’s a quick overview and a few things to consider:
First, every business owner needs to understand how businesses are taxed. Generally, there are two taxable options:
- The taxable entity, otherwise known as the C corporation
- The pass-through entity, which may refer to the sole proprietorship, general partnership, limited liability company or Sub-Chapter S corporation.
Traditional C corporations pay corporate income taxes on annual net profits, then issue dividends to its shareholders. The shareholders then pay individual taxes on the dividends. This double taxation is generally not favorable for most small business owners given the double tax and administrative burden associated with this structure.
The pass-through entity is usually more favorable for small businesses and entrepreneurs, given that all of the net profits and expenses (gains or losses) pass-through the entity and go directly to the principal (proprietor, member or shareholder). As a result, the entity does not pay any income tax. Instead, the tax consequence is passed on to the individual principal who pays federal, state and sometimes self-employment taxes on their percentage of the distributions or dividends. The goal here is to simplify the process: one set of taxes at the end of the year.
Determining your tax structure is something that should be done with the advice of an expert. This short overview does not address deductions, write-offs, capital, depreciation and other tax matters that should be explored.
For more info on tax strategy or to have your taxation questions answered, please feel free to contact me at email@example.com