Tax classes for companies: How should I structure my business?
By Melissa G. Cassell
The first question any entrepreneur faces is what type of business to create and what legal entity to use. The answer typically determines which forms to file and what taxation the company will have (at least initially). Here is a summary of the options:
Sole Proprietorship – default taxation for single-owner entities (including LLCs). Easy startup – No election or initial filing required. Owner reports all income on a 1040 since the entity is not actually taxed and thus, no additional return is required. Downfall: all net income of the entity may be subject to self-employment tax AND owner is taxed for all profits of entity even if no money is personally withdrawn.
Partnership – default taxation for multiple-owner entities (including LLCs). Easy startup – No election or initial filing required. Owners report all income on 1040 via a K-1 since the entity is not actually taxed and thus no additional return required. Downfall: all net income of the entity may be subject to self-employment tax AND owners are taxed for all profits of entity even if no money is personally withdrawn.
C Corporation – default taxation for corporations and available for certain other entities (including LLCs). No election or initial filing required. Potential for lower income tax rates, self-employment tax savings, and greater flexibility in reporting losses (as compared to sole proprietorship or partnership tax). Downfall: earnings are taxed to the corporation and the owners (double taxation).
S Corporation – available for LLCs and corporations BUT requires an election to be made by the entity, no later than 2 months and 15 days after the beginning of the tax year in which the election should take effect (though there is relief for certain late elections). No double taxation concern, as you have with C corporation tax, and greater flexibility in reporting losses (even when compared to C corporation tax). Recommended if an entity that would otherwise have sole proprietorship or partnership tax has payroll (i.e. W-2 employees), as there are potential employment tax savings. Downfall: the entity cannot have more than 100 shareholders, each shareholder must be an individual or otherwise meet the IRS’ taxation requirements, only one class of stock may be issued, and distributions must be made proportionately to owners.
Melissa Cassell is an attorney with Morton & Gettys LLC in Rock Hill, South Carolina. Her practice includes employment, business/corporate and commercial real estate law.
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