Basic Taxation Aspects for Entity Choice

Consider your tax options when deciding on entity choice.

When deciding on what type of entity to utilize for a business, there are any number of factors to consider. The modern approach suggests that the primary options are the corporation and the limited liability company (LLC). Both offer limited liability protection of their respective owners, but many other attributes of each differ in substantial ways. One such aspect is how each entity is taxed.

The basic tax structure of the LLC is the pass-through model. Whether you have a single owner LLC, which is considered by the IRS for tax purposes as a “disregarded entity”, or the LLC has multiple owners, which is treated as a partnership by the IRS for tax purposes, pass through taxation essentially means that the revenues of the LLC pass through the entity level directly to each owner, who then report their respective share of profit or loss in the company on their individual tax returns. The entity does not itself pay taxes.

Then there is the default corporate tax structure, the c-corporation. When a corporation is formed, the default is that a c-corporation was formed. Under the c-corporation structure, revenues of the corporation are treated as revenues of the entity itself and are taxed at the corporate level. Any distributions or dividends then paid to the owners are reported on the individual returns of the owners and are taxed at the individual level. This is the “double taxation” problem that corporations pose for many business owners. Despite this double taxation aspect, the c-corporation may still be the appropriate tax structure for your entity, based on business type, ownership structure and other factors.

A third option exists for business owners, the s-corporation. Not an actual entity type, an owner does not form a subchapter s corporation. Instead, either an LLC or a corporation is formed at the State level and the owner(s) then affirmatively elect with the IRS to be taxed as an s-corporation. This is understandably a source of confusion amongst business owners. Legal formalities aside, however, the s-corporation can offer a useful and money saving alternative to the default LLC or corporation tax model, including offering a way to minimize their costly self-employment tax that all LLC owners must pay. Unlike with c-corporations and LLCs, there are rules and limits on who can be owners and how many owners there can be.

There are intricacies and nuances to each tax model, with pros and cons to each that may or may not make a given structure appropriate for your business. As such, always consult your attorney and CPA before deciding upon entity type and tax structure.

LEGAL DISCLAIMER

The information herein is not legal advice and does not create an attorney/client relationship. The information is in the form of legal education and is intended to provide general information about the matter.  The above is not, nor is it intended to be, legal advice.  Consult your attorney with questions.