Tax Considerations for Different Business Structures

Starting or restructuring a business requires careful thought about how it affects you and your business. A business formation attorney can explain the tax consequences of different business structures. This lets you choose the best option for your situation.

Sole Proprietorships

A sole proprietorship means you run the business alone, without forming a separate legal entity. Sole proprietorships are “pass-through” entities, meaning that they are not taxed as a business. As a result, all income to the business is taxed as personal income of the owner of the business at his or her individual income tax rates.  Income received from a sole proprietorship is also subject to self-employment taxes but sole proprietorships are not subject to Texas state franchise taxes.

Partnerships

Partnerships involve two or more people running a business together. There are general partnerships, limited partnerships, and limited liability partnerships, each of which has specific advantages and disadvantages. For tax purposes, however, partnerships are considered pass-through entities similar to sole proprietorships. As a result, all income to the business is taxed as personal income to each of the partners. Income received by a general partner is subject to self-employment taxes, but income received by a limited partner is not.  Limited partnerships and limited liability partnerships are also subject to Texas state franchise taxes, though franchise taxes may not be owed depending on types and levels of products and services.

Limited Liability Companies (LLCs)

LLCs are separate legal entities distinct from their owners. A single-member LLC or one owned by spouses in Texas may be taxed like a sole proprietorship (a disregarded entity). LLCs owned by more than one member may be treated as a partnership for tax purposes. Owners of LLCs also have the option to elect to be taxed as a C-corporation or an S-corporation. If taxed as a pass-through entity (a disregarded entity, a partnership or an S-corporation), then all business income becomes the owners’ personal income. If taxed as a C-corporation, the income of the business will be taxed at the entity level, and the income the owners receive from the business will be taxed as personal income.   LLCs are also subject to employment taxes and Texas state franchise taxes, though no franchise taxes may be owed depending on types and levels of products and services.

S-Corporations

S-corporations are another type of pass-through entity with no income tax liability at the corporate level. Corporations, LLCs and even partnerships can be treated as an S-Corporation for tax purposes.

Owners of an entity treated as an S-corporation for tax purposes must pay personal income tax on any income received from the corporation. S-corporation owners are also subject to self-employment taxes, but only on the salary portion of their compensation, which must be reasonable.  Profits beyond salary are not subject to employment taxes.  As such, tax treatment as an S-corporation can be advantageous when the company generates income in excess of salary; however, the IRS imposes certain standards for qualifying as an S-corporation, so not all companies will qualify. S-corporations are also subject to the Texas franchise tax, but there is no state income tax for the owner’s share of the company’s income.

C-Corporations

C-corporations pay corporate income tax, and shareholders pay personal income tax on dividends. This is sometimes referred to as “double taxation.”  Owners are not subject to self-employment tax, but the C-corporation pays the employer’s portion of these taxes.   C-corporations must also pay the Texas state franchise tax where applicable.

Contact J Nichols Law, PLLC, to Discuss Business Formation Tax Strategies

Choosing the right business structure affects your taxes and legal liability. We can help you understand your options and choose the best structure. To discuss what business formation makes the most sense for you, call J Nichols Law at 409-257-7878 or send us an email to schedule a consultation.