As a business owner, the decision to choose the right business formation is not a light decision.
One of the important factors that demand careful consideration is the potential tax implications associated with different business structures.
1. Sole proprietorship
A sole proprietorship is the simplest form of business structure. In this setup, the business and the owner are a single entity. From a tax perspective, the business’s income and expenses are part of the owner’s personal tax return. This simplicity is advantageous, but it also means that the owner is personally responsible for all business liabilities.
2. Limited Liability Company
An LLC offers a blend of simplicity and liability protection. Business owners can choose how they want the IRS to tax their LLC, including as a sole proprietorship, partnership, S corporation or C corporation. This flexibility allows owners to tailor the tax structure to their specific needs. However, owners must be cautious to adhere to all regulatory requirements to maintain their liability protection.
An S corporation is a tax designation rather than a business structure. When a business elects S-corporation status, it means the business itself does not pay federal income taxes. Instead, profits and losses flow through to the shareholders’ individual tax returns. This structure helps avoid double taxation. In 2019, 52.4% of small employer businesses used this type of business formation.
Each structure has its own tax advantages and considerations, so it is important to weigh the options carefully before making a decision that aligns with both business goals and financial well-being.