When acquiring or starting an business, some of the most common things to consider is the ease of operation and compliance, taxation impacts of the business structure, as well as flexibility when raising capital, scaling and bringing on partners or shareholders. A business should also consider implementing accounting processes that will aid its smooth operation. This article will explore tax tips and considerations for starting new business ventures.
The most suitable entity structure for your business
There are several entity structures that businesses can choose from. Each structure comes with its advantages and drawbacks. The entity type that would work best for your business depends on different factors such as the size of your organization, your preferred tax structure, and more. A small business accountant can help you choose the structure that will suit your needs best.
We take a look at the four most common entity types below:
Single-member limited liability company
Single-member limited liability companies, or SMLLCs, are one of the most common types of new businesses in the US. It allows you to pass through your net income without an initial tax assessment. This flow-through net income is then subject to the regular marginal tax rates that most individuals are subject to. The downside is that you may also be responsible for the full self-employment tax. Keep in mind that this isn’t always the case, but it would be worth looking into with your CPA.
On the upside when using an SMLLC, you aren’t required to file a separate tax return as the activities of your business can simply be reported on your 1040 tax form via the Schedule C. You also do not have to put yourself on a W-2 salary with a payroll company if it is just you operating the business. This would ease your monthly administrative costs.
S- corporations
An S Corp is an excellent choice for owners who wish to incorporate their new business. It is a type of corporation wherein the net income flows through to shareholders without the risk of double taxation. Another compelling reason why many business owners choose this entity structure is that they may not be wholly subjected to the self-employment tax that SMLLC owners may be liable to pay.
S Corporations do however require that owners who are providing services to the entity are paid a reasonable market salary via a W-2. Another point to note when consulting with a CPA about selecting this business structure is that owners are required to file a separate business tax return (Form1120S), which is a separate filing from their personal taxes (Form 1040).
Partnerships
Partnerships work particularly well when you are raising capital and need to have a creative structure for granting people or employees equity over time. You can also be very creative with your profit, loss and distribution allocations; as opposed to S Corporations which can be very rigid from this perspective.
In a partnership, a member (investor) could have a 20% capital stake in an entity yet have a 70% profit allocation and a 10% loss allocation. Total flexibility. This is opposed to an S Corporation, where if you own a 30% capital stake you are required to get exactly 30% of the profit, loss and distribution allocations.
Partnerships also work as the parent holding companies, if you’re planning to have a tiered entity structure and subsidiary investments at some point. On the downside, generally from a tax perspective, the profits can be subject to Self Employment taxes. There are a lot of caveats and quirks to this treatment, so every situation must be analyzed on a situational basis.
C- corporations
C Corporations are the least common among small businesses due to the double taxation of profits. This should not be taken lightly. Meanwhile, they are the most common for high growth companies that are also raising significant capital and have eyes on potentially going public one day.
Tax tips for starting new businesses
The entity structure and nature of your business are factors that determine your tax filing requirements. Some businesses pay annual taxes while others make quarterly submissions to the IRS.
To learn more about tax considerations and tips for starting a new business, speak to a CPA that understands IRS tax guidelines for different entities.
This blog article is not intended to be the rendering of legal, accounting, tax advice or other professional services. Articles are based on current or proposed tax rules at the time they are written and older posts are not updated for tax rule changes. We expressly disclaim all liability in regard to actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive.
