Best Small Business Tax Structure

By Dave Horwedel, EA

There is a C-Corporation which is the major corporations like those you see on the stock market. C-Corporations have stockholders, and they can make a lot of money. They have corporate meetings and boards of directors’ meetings and so on. They pay 21 % corporate income tax on the profits that the corporation makes.

Then they pay their shareholders in dividends and the shareholders pay individual taxes on the dividends they receive. This is referred to as double taxation, as they are taxed on the individual and corporate level.

There are reasons corporations do this.  One reason is that they do not have much choice. They are often too big to be treated as S-Corporations. There are advantages to being a C-Corporation. They can be listed on the stock market. They are attractive to investors.

The small businessman is usually better served by the S Corporation. The other type of corporation is called an S-Corporation. An S-Corporation is a small business corporation. It has limits on how much money it can make. It can’t have more than 100 shareholders. It cannot have foreign investors. A major thing about an S-Corporation is that the income it makes automatically flows through to its shareholders, so it never makes taxable income as a corporate entity. It all gets credited to the individuals who own it, so there’s no double taxation.

The S-Corporation is not taxed at the federal level. Some states (e.g. California, Tennessee) tax S-Corporations at the state level. This decreases but does not eliminate the S-Corporation’s tax advantage in these states.

An S-Corporation is called a flow through entity because its profit or loss flows from the federal corporate return to the individual stockholder’s return. Limited Liability Companies, Partnerships, and Sole Proprietorships also flow through entities. The business profit or loss flows from the business to the individual 1040 tax return.

So, what is the advantage of the S-Corporation?  These other entities (LLCs, Partnerships, and Sole Proprietorships are also flow through entities BUT are automatically subject to the Self Employment (SE) Tax.  This is the Employer’s and Employee’s contribution to Social Security and Medicare COMBINED, i.e. 15%.

On $100,000 of profit this is $15,000 In SE Tax in addition to Income Tax.  OUCH!

Now, an S-Corporation can save much of this money. The taxpayer will need to file an S-Corporation tax return form 1120S. Moreover, the corporation will need to pay reasonable compensation to shareholder employees and pay them on a payroll.

For a small business making $30-300K profits per year, this is often worthwhile.  If you are curious about how this might affect your taxes, you are welcome to contact us for a free consultation.

There are also asset protection advantages to S-Corporations and LLCs. Asset Protection is commonly underprioritized by business owners and this can be a major mistake. You are welcome to contact us at Guard Dog Tax and Torchlight Tax (these are sister companies) and we can review the benefits of an S-Corporation for your exact situation.

Now, there is one other entity that’s not actually a corporation, but everybody thinks it is. It’s called a limited liability company, or LLC.

Now, the funny thing about an LLC is that it can apply to the Internal Revenue Service to be treated for tax purposes as an S-Corporation.

Now a C-Corporation, if it meets the qualifications, can also apply to internal revenue service to be treated for tax purposes as an S-Corporation.

This is because S-Corporation is a tax status, not an entity.

LLCs and Corporations are formed as entities at the state level.  They can apply for S-Corporation tax status at the federal level.

If an LLC does not apply for S-Corporation tax status at the federal level, it is viewed by the IRS as a disregarded entity.   If this occurs, a single member LLC would file as Sole Proprietor.  An LLC with more than one member would file as a Partnership.

Now if a corporation does not file for S-Corporation tax status, the IRS will treat it as an S-Corporation.

For most small businesses, there is little practical difference between an LLC or Corporation.

Fees can be different. Corporations sometime have extra requirements. Feel free to contact us if you have any questions here.

I realize some of these points may seem unnecessarily complex or picayune.

You are welcome to contact us to discuss your own unique situation or email us  at info@Guarddogtax.com or info@torchlighttax.com. We offer a free consulation.

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