Structuring Your Business for Tax and Legal Implications

Establishing a business is exciting, and it takes a lot of work.  From raising capital to hiring staff to creating sales strategies, there are countless things requiring your focus.  Choosing the best business structure often falls low on the priority list – but it shouldn’t.  There are substantial long-term implications surrounding the choice, including the amount of taxes you have to pay, your ability to raise capital, and which assets are at risk due to business losses.  By putting in a little bit of effort early on and getting expert advice, you can save significant time and effort and improve profits.

For an initial overview, read our post: Understanding the Differences Between the 6 Major Business Entities.  In this post, we’ll discuss the tax, legal, and financial implications of each business entity structure.

Sole Proprietorships and General Partnerships

Tax Implications – For both of these business entity structures, the individual and business profits and losses are closely intertwined.  The owner or owners report earnings or losses on their individual tax return(s) and aren’t subject to corporate taxes.

Legal Implications – Since there isn’t a separate business entity, the owner(s) are held personally responsible for all business debts and liabilities.  This means that personal assets are at risk in the event of bankruptcy, lawsuits, or other costly circumstances.

Financial Implications – Without being a registered business entity, it can be challenging to get loans, attract investors, or land larger contracts.

Limited Partnerships

Tax Implications – There are two types of partners in a limited partnership – the general partner who operates the business and the limited partner who invests in it.  The limited partners often pay lower taxes due to their less substantial role.

Legal Implications – General partners assume full personal liability for all business debts, while limited partners are protected from the liability.

Financial Implications – Limited partnerships are more attractive for investors because of the liability protections.  This means the general partners are more likely to get the funding they need without sacrificing operational control.

C-Corporations

Tax Implications – Shareholders in a C-Corp pay lower self-employment taxes, but the profits of the company face double-taxation.  First, the company pays taxes on its corporate tax return, and then the individual shareholders pay taxes on their personal tax returns.  While owners can’t deduct business losses on their personal taxes, C-Corps are eligible for more tax deductions than any other business entity.

Legal Implications – The C-Corp business entity provides the strongest personal liability protection of any other type of business. Instead, the corporation remains liable for any losses that occur, including those from lawsuits.

Financial Implications – Corporations have an advantage when trying to raise capital, as they can raise funds through the sale of stocks.  This structure is ideal for medium- to high-risk businessesand for those who are considering transitioning into a publicly traded company.

S-Corporations

Tax Implications – The S-Corp business entity is designed to circumvent the double-taxation of a C-Corp by allowing profits and some losses to “pass through” directly to the shareholders personal income.  This means the shareholders can avoid the corporate-level taxes. Specific taxation depends on the state in which your business is registered.

Legal Implications – Providing the best of both worlds, S-Corps maintain the personal liability protections of a C-Corp.

Financial Implications – S-Corps are subject to stricter rules surrounding the issuing of stock, which can impact investment opportunities.

Limited Liability Company

Tax Implications – LLC owners benefit from lower tax rates than corporation shareholders because they can choose to be taxed as a sole proprietorship/general partnership. This helps them avoid corporate taxes.  Each owner is still responsible for self-employment taxes.

Legal Implications – With “limited liability” right in its name, owners of an LLC have more significant protections than with a sole proprietorship or general partnership.  In many cases, their personal assets are not at risk in the event of bankruptcy or lawsuits.

Financial Implications – LLCs are more costly to establish than a sole proprietorship or general partnership, but for many, the benefits are worth it.

Choosing the business structure that’s right for your business requires an analysis of your unique situation.  With over 35 years of experience, Hall & Company’s Accounting and Business Consultants have guided countless companies through the process of establishing the best business entity for their circumstances.  Contact usvia email or call our offices at: 949-910-HALL (4255).

 

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