What is a business structure?
A business structure is the type of organization, termed “business entity”, which you get to choose when registering your business with the IRS for tax purposes-also called the “tax entity.” The identification of the business determines how taxes are taken from revenue, how many tax deductions are awarded, and the amount of taxes that are paid at the end of the year. Ownership and personal income distribution are also determined by the structure of your business. Below are two of the most common entities that companies choose.
C Corporation and LLC Structures:
C Corporation:
- Taxes: C corporations are subject to what is called the “double tax.” What this really means is that the incomes of the corporation are taxed at the end of the year as revenues. Then when the corporation pays out dividends to its shareholders, those revenues are taxed again even though they are drawn from the same source of income, being the end of the year revenues, which have already been taxed once. Therefore there is an additional round of taxing before the shareholder sees any money back on his investment than with a LLC. However some corporations are eligible to identify as S corporations which means that they do not have to pay the traditional double tax corporate system.
- Non Pass-Through: C corporations are non-pass through entities which means that the shareholders’ personal incomes are considered separate from the corporation’s income, this is part of the reason that they have to pay the double tax. One way that many owners get around this is to elect to structure the company as an S corporation, which is a pass-through entity in the same way as an LLC. Due to the separation between business and owner, C corporation owners enjoy flexibility in labeling revenues as “retained” or in paying them out to owners as dividends or salaries.
- Employee benefits: Certain kinds of securities are only available to employees of a C corporation, such as discounted stock purchases and there are many fringe benefits that larger C corporations are willing to pay for their employees. Additionally, by offering certain benefits to their employees, the corporation can have some of the costs of offering those benefits deducted from its taxes. C corporation owners only have to pay Medicare and Social Security taxes on their salaries, any income from dividends and profit distribution are not taxed by these specific taxes.
Limited Liability Corporation:
- Limited Liability: Normally, members’ assets are protected from personal liability in the case of debt incurred from business or from lawsuits. However, there is a “limited” amount of liability meaning that there are some wrongful acts (legally and financially) that members or their employees can commit that could potentially end in a lawsuit for which they would be held personally liable.
- Taxes: The tax structure of an LLC is meant to be more flexible than the corporate system where revenues have to be awarded to the shareholders in the form of dividends and are taxed twice. However this means that since the business and members are not separated then their income is taxed as a lump sum, they cannot make a distinction between what is reinvested in the business and what is taken home by members. However, the IRS does require notification of how much money is given out in each member’s share of income in a multi-owner LLC. It should be noted that an LLC is formally a legal entity with no specific tax structure. Due to this an LLC can elect to be taxed as a proprietorship or as a corporation of some kind.
- Pass-through: The members of an LLC are considered to be a single entity with the business. This means that the businesses revenues and debts are passed through onto the personal income statements of each member. LLCs can also elect to be a non-pass through entity in the same way as a corporation, though this will change other rules as well.
- Employee Benefits: LLC members are not considered employees and their personal income is not subject to social security or Medicare taxes. Also, LLC members are not offered the same tax deductions as C corporations when it comes to offering employee benefits.
There are many different ways to structure your business’s taxes to suit your preferences. There is no such thing as a “best structure” or “one size fits all” approach. To help find a business structure that is the best fit for your business, contact the Goosmann Law Firm at info@goosmannlaw.com or (712) 226-4000.