Business Entity Planning & Conversion
What Kind Of Business Entity Might be Right for Me?
There are a variety of entity types available when you incorporate a new business. It’s important to consider the various advantages and disadvantages that each business structure provides. For many business owners, it can be difficult to compare these entity types directly to determine which is the right choice. And the appropriate type depends on the business’s needs.
Use our Business Entity Comparison Chart to help you decide which entity makes the most sense to help you meet your business goals. Below are some very simplified descriptions of the different business entities available. And if you’re starting a business and need advice on what entity is best for you, please call us at (303) 745-3962.
Sole Proprietorships & Single-Member LLC’s
The most common businesses people start are the sole proprietorships or single-member LLC’s. Both are easy to start with little more than saying “I’m in business.”
The single-member LLC is just a sole proprietorship with a tad more business liability protection, though it’s important to remember that you may still need an umbrella policy or some further liability protection or an E&O policy (errors and omissions) depending on the business specifics.
Sole props and single-member LLC’s file their taxes on a Schedule C which is a part of the 1040 series and is just attached to your personal return. It’s an inexpensive tax filing. What most people like in starting out with one of these is that any business losses can be applied against other taxable income to reduce the tax bill.
What people don’t like is paying self-employment tax on their profits.
Wikipedia has a good definition of a partnership. “A partnership is an arrangement where parties, known as business partners, agree to cooperate to advance their mutual interests. The partners in a partnership may be individuals, businesses, interest-based organizations, schools, governments or combinations.”
These can be easy to setup but become more complex as more money and more names are involved. There should be a partnership agreement in place before the business starts but this is often put off and can lead to disagreements and business failures down the line.
Partnerships (known as a pass-thru entity) file their tax returns on a Form 1065 Partnership return which is separate from the personal 1040. K-1 forms are generated in the return preparation that are given to each member of the partnership to show income or losses and a number of other items on each partner’s personal return. Unlike a Schedule C business, losses are limited to basis (ownership) in the partnership. Losses that exceed basis are carried over to future years until basis limitations allow them to be deducted. Profits are subject to both income and self-employment tax (except in case of limited partners).
Corporations are entities that are separate from the individuals that form them. Usually corporations include more than 1 person but a single person can setup a corporation that is apart from him/her self.
The default incorporated entity is a C Corp. If an S Corp is desired, you setup the C Corp and then elect to become an S Corp.
The most common reason for forming an S Corp is to reduce self-employment taxes. This is a well known and popular strategy for growing businesses that have enough profits where the self-employment tax has become an issue. The S Corporation has the same history of liability protection, for the most part, as a C Corp.
Deductible losses in an S Corp are also limited to the shareholders basis in the business. Losses that exceed basis are carried over to future years until the basis limitations allow them to be deducted. S Corps are also known as pass-through entities as profits or losses are carried to the owners personal returns on the K-1 form. The tax form used is the 1120S.
C Corps pay taxes on their profits, profits or losses are not passed thru to the shareholders.
An issue with C Corps is the double taxation of dividends. If the corporation makes a profit, taxes are paid on that profit. The corporation can then pay out some or all of that profit in the form of dividends to individual shareholders. The shareholders then pay taxes again on the income that was already taxed. The Trump tax changes in 2018 helped this problem quite a bit when the law was passed in 2018 but it didn’t eliminate it.
One of the best features of C Corps is the deductibility of fringe benefits. These deductions are less limited in C Corps than they often are in S Corps.
If you're an individual, a family or a small business, we can help you with all your tax needs. Contact us today to see how we can help.