The Best Business Structures for Optimal Tax Efficiency

Starting a new business requires planning. You to have a strategy that is well thought out. And not every idea comes together in sequential order. Some companies start out with a vision, craft a mission statement, and then decide upon products or services to be offered. Entrepreneurs pull together ingenious ideas for companies and prepare their sales pitch in attempts to secure funding. They then go before capitalists, bankers, or lenders and get a host of different responses, and are oftentimes met with “no” as an answer. Persistence is key.

No doubt company founders lose sleep from worry even after having spent hundreds of hours in business development to ensure that they have in place the best chances at achieving success in their new venture. One such step, though, that isn’t talked about much is how to decide on the best business structure for the type of company they are starting and the employees who may ultimately work there. Business designations can be tricky to explore because these newly minted managers are entrepreneurs, not legal experts. However, if you’re a new business owner, there are some general questions that you can ask yourself as you begin the exploratory process of choosing the best business structure for your company type.

Business Structure Considerations

How you structure your business entity will depend a lot on your business model, the types of products and services you intend to offer, and the number of people it will take to deliver what you sell to your customers. A business model can mean a few different things, depending on the industry or who to whom you might be speaking. For example, companies that engineer products need both factory space and administrative offices. The IRS considers these distinct working spaces for tax deductions, which will impact the way that you file.

Firms that deliver services need only corporate offices. Some companies rely heavily on hiring contractors to fulfill the work they need. They may only need a few full-time employees. In this case, they are only responsible for collecting government payroll and other FICA taxes for their direct-hire employees. Any number of employees means you need to have an employee identification number (EIN) issued to fulfill these requirements.

Other companies use a mix of full-time, part-time, and contract labor services to give managers flexibility for changing demands of the business. Companies nowadays hire employees that can be successful working remotely. Registering for the taxation of business entities doesn’t have to be a nerve-wracking decision if you have a well thought out plan.

Stocks or No Stocks?

At a high level, you can begin by deciding whether you want your company to have treasury stock that it can issue and sell. S-Corps have stocks. If you’re the only business owner, do you want to sell a portion of your business to an investor or partner later? Whoever owns shares of stock in the S-Corp is responsible for paying taxes on the portion of stocks that they own. S-Corps can have up to 100 shareholders of privately held stock, but there isn’t a limit on the number of employees. FICA taxes must be collected, recorded, and filed for every employee. For stockholders, however, the S-Corp income gets passed through.

Technically, an S-Corp can exist without employees if all income payments pass to its shareholders. Any distribution of salary payments to owners is calculated under payroll income rules and dividends from stock under IRS capital gains rules. The advantage of S-Corps is that, being partly compensated through payroll, the taxable income as capital gains is lower. Be sure to check with an accounting professional to see if your payroll style income falls under the Qualified Business Income Deduction (QBI) rules for 2018 to present.

Alternatively, C-Corps are publicly-traded stock companies with no limit on the number of shareholders. Each is required to have a Board of Directors. Any legal claims against the company remain with the entity, and officers and directors are not liable.

Types of Business Structures

C-Corps and S-Corps 

To begin with, you must decide whether in the future you will want the general public to invest in your company to facilitate future growth. If so, you want the company to register as a C-corp with a predetermined number of shares to be issued for public trade. C-corps are familiar to all of us as large global companies with hundreds or thousands of employees. However, this isn’t always the case. Some C-corps have smaller numbers of employees and only issue a portion of total shares. They can register multiple share classes: class “A”, class “B”, and so on. Any unissued shares are called treasury stock. Further, publicly traded C-corps are required to register with the SEC and file quarterly 10-Q and annual 10-K financial reports. Otherwise, your C-corp can be a privately held company.

S-corps are different because they can be owned by one person or up to 100 individuals. S-corp owners gain the tax advantage as a pass-through entity for business profits and losses. S-corps only have one share class and owners can transfer ownership through the sale of stock. If you want the flexibility of selling part of your company’s equity, this is a business structure option to consider.

Limited Liability Companies (LLCs) and Partnerships

LLCs, or domestic LLCs, are Limited Liability Companies. For tax purposes, the IRS considers these pass-through entities. While someone may come after your company profits via a lawsuit, personal property is much more difficult for a complainant to target. You are only liable for the amount you invested in your company. When you run your own LLC, you don’t need to apply for a separate employee identification number (EIN). However, if you intend to hire employees, you need an EIN immediately. 

What Makes Limited Liability Partnerships (LLPS) Different?

Limited Liability Partnerships (LLPs) also function as pass-through entities for those registered as managers of the organization. Business owners with certifications such as attorneys, accountants, and other professionals who are required to operate under a state-issued license are usually better fits for LLPs. No single individual is responsible for paying taxes for the entire operation. If any partner fails to fulfill their legal obligation, under state law, the remaining partners can buy them out or remove them.

Limited Liability Partnerships (LLPs) allow professionals to share their expertise, workload, resources, and business liability. You see these suffixes commonly displayed in the titles of law firms, accounting firms, and other licensed professionals, such as architects. Like LLCs, LLPs protect the partner’s personal assets from creditors and legal challenges. They also allow individuals to enter and exit the partnership agreement more easily. LLPs are required to file annually. Partners are required to file taxes individually like an LLC pass-through entity, except on their portion of profits.

The Tax Cuts and Jobs Act of 2017 included a provision for a deduction of up to 20% on Qualified Business Income (QBI) from a qualified trade or business for estates, trusts and individuals who are owners of sole proprietorships, partnerships and S-corps. The deduction has various components and is subject to limitations. Consulting with a seasoned tax professional to make sure that you benefit from all the current rules as well as minimize the chances of filing incorrectly should be a key step in your business planning.

What Are Domestic and Single-Member LLCs?

Limited Liability Corporations (LLCs), (D)LLCs (domestic), can also be called Single-Member Limited Liability Corporations (SMLLC) if you are the only owner and your company is not international. LLCs provide most business owners a great deal of flexibility when considering taxation of business entities. Most general consulting services choose to register as an LLC. Under the Tax Cuts and Jobs Act of 2017 (TCJA), LLC owners can deduct 20% taxable income up to $157,000. LLCs work very well with SEP-IRAs as a tax benefit since you can invest pre-tax income of up to $55,000 into your retirement account, thereby lowering your total adjust gross income (AGI). With so many options to consider, it’s smart to choose a good tax expert who can help navigate the ins and outs of any structure.

Sole Proprietorships: The Simplest Business Structure

Sole proprietorships do not need fictitious name registrations. Any name other than your birth name being used for business purposes must be registered with the owner, yourself, listed as an officer or manager of the company. You must complete the LLC paperwork and filing fee with the Secretary of State (SOS) and pay the annual registration fee. Then, you can take advantage of the designation to apply for qualified tax deductions. What it could mean for you is a higher net income when you itemize your business expenses to file your taxes.

Small Business Considerations for Optimal Tax Efficiency

You don’t need to own a massive company to do what you do well. If this is you, then you don’t need to register as a C-corp with 1 million shares of stock on the books. Smaller companies in the range of 50 to perhaps a few hundred employees will do well structuring their business as an S-corp, LLC, or LLP. All will provide the benefits of pass-through taxation. LLCs can grow as large as you want when there isn’t a need for partnership agreements. However, some might argue that the LLC is a safer bet.

Talk to an Expert When Choosing or Changing Your Business Entity

Ultimately, you are a growing entrepreneur, not an attorney. Whatever business entity you are working within, it’s important to understand the benefits and limitations of how your structure will be taxed. Leave the heavy lifting to those who can provide expert advice. As the owner of a new company, the best approach to take is to focus on launching your business. SD Mayer’s tax and legal team will help you to decide on what business structure will have the best tax benefit so that you can concentrate on just doing what you do best: leading the way.

The professionals at SD Mayer want your business to succeed. We will sit down with you and help plan your optimal business structure every step of the way with our decades of knowledge behind us. Contact us today to get the process started.

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