Entrepreneurs get very serious when they get to the point where they need to decide what legal business structure to form – limited liability company (LLC), Corporation, S-Corp, partnership, etc. How taxes fit into your consideration when selecting the best legal entity for your business, is important. We’ve put together a brief overview and some things to consider before you make your decision.
Every business owner needs to understand how businesses are taxed. Generally, there are two taxable options: the “taxable entity,” otherwise known as the “C” corporation, and the “pass-through entity,” which may refer to the sole proprietorship, general partnership, LLC or Sub-Chapter S corporation.
Traditional “C” corporations pay “corporate income taxes” on annual net profits, then issue dividends to its shareholders, who then pay individual taxes on the dividends. This “double taxation” is generally not favorable for most entrepreneurs and small business owners, given the double tax and administrative burden associated with this structure.
However, the pass-through entity is usually more favorable given that all of the net profits and expenses (gains or losses) “pass-through” the entity and go directly to the principal (proprietor, member or shareholder). As a result, the entity does not pay any income tax. Instead the tax consequence is passed on to the individual principal who pays federal, state and sometimes self-employment taxes on their percentage of the “distributions” or “dividends.”
The taxation of entrepreneurs and small businesses is to simplify the process; pay only one set of taxes at the end of the year. To help you determine what is best for your business, consult a tax specialist, tax attorney, or your accountant.
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