Entrepreneurs have a long list of special opportunities to save on taxes. However, your eligibility for some tax breaks depends on the decisions you make as you are planning and launching your business. One of the most critical choices is which business entity you will operate under. A Certified Tax Coach walks you through each of your options, spelling out the benefits and drawbacks of the most common business structures.
Business Entity Basics
It’s no surprise that you must pay taxes on any income your business generates, but you might not realize that the same income can be taxed differently depending on how your business is organized. While some types of businesses are considered separate taxpayers from their owners, others require that you include your business income on your personal tax returns.
Your tax rates aren’t the only thing impacted by your choice of business entity. The structure you select affects whether you are personally responsible for business debts and whether you can be held personally liable if the business is sued. When your business exists as a separate entity, the business itself can apply for credit, and these types businesses can continue to operate when you decide to move on or retire.
These are a few of the most common options:
Sole Proprietorships and Partnerships
When you are starting out and working alone, it is easy to operate as a sole proprietorship. Essentially, you and your business are one and the same for tax and legal purposes. Simply register your business name with the state, and you are ready to launch. You can still have employees as a sole proprietor, but you own the entire company.
The simplicity of this structure makes it quite popular, but it isn’t always the best choice for entrepreneurs. Business income is treated the same way as other personal income for tax purposes, and you assume full liability for all business debts and legal issues. That puts your personal assets at risk.
Though there is slightly more paperwork involved, a partnership is quite similar to a sole proprietorship. Taxes and legal liability are the responsibility of all partners, and partners can be sued individually or collectively for the actions of one business owner.
Limited Liability Companies (LLC)
It is common to see the initials LLC after many small and medium-sized business names, and there is a good reason for that. LLCs offer business owners many of the protections that larger corporations enjoy, without the complexity and cost associated with incorporation. With LLCs, business owners are considered separate from the business itself for the purpose of taxation and legal liability. This can lead to significant tax savings, and it protects personal assets from business-related debts and lawsuits.
Of course, setting up an LLC is more complicated that operating as a sole proprietor, so some entrepreneurs choose to hold off on this step until the business begins to be profitable.
Your choice of business entity can dramatically impact your bottom line tax bill, and it will affect your long-term level of risk as the organization grows. To learn more about your options for structuring your business, work with a Certified Tax Coach.