The type of corporate structure, that is, which form of corporate entity you decide to use, is one of the single most important planning decisions a business can make when it’s time to consider tax advantages. It is usually one of the areas where the most misinformation is given and mistakes are made. Most businesses eventually choose to incorporate in some form or fashion, and this can have a number of benefits, both from a legal and a tax standpoint.
Before you let yourself get into trouble with the murky waters of choosing a type of corporation for your business, check out this overview to learn more.
When possible and under the right circumstances, S-Corps are considered to be the “best of the best” of tax entities. They offer the same legal protection as the other entities but have one major advantage: Earnings in excess of the shareholder’s salary are not subject to self-employment tax. And the savings is not in taxable income, but in actual tax to be paid.
Wal-Mart, IBM, and other major corporations are C-Corporations. This is because business with 1) more than one class of stock or 2) more than 100 shareholders are not given the option of S-Corp election. What are the benefits?
The stock is able to be widely traded. This makes raising capital much easier and also makes the ownership readily transferable. It allows for different classes of stock, which plays a major role when corporate decisions are at stake.
There are disadvantages to a C-Corp, also. The corporation itself is taxed and then any earnings that are disbursed to shareholders, as dividends, for example, are also taxed. In effect, double taxation. As small business owners, there are few circumstances that would warrant taking this tax hit.
LLCs are probably one of the most popular entities for small business owners and with good reason: They are easy to form and they give the owner the benefit of limited legal liability.
If there is only one owner, they can be treated as a “disregarded entity”. This means they do not require a separate tax return and all income can be done on Schedule C of the 1040. This saves money on tax preparation and is an easier process. There are a lot of circumstances where they are the most advisable approach. But they have one major disadvantage:
As a default, all of the earnings are considered self-employment income and are thereby subject to self-employment tax.
Remember, your company is unique, even though there may be a thousand other companies in the same business as you. Make sure to take the time to sit down with a professional and discuss your personal situation to see what approach will be the best for you.
Ready to learn more? Check out the WISE LEARNING SERIES of educational e-resources!