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Tax Considerations for Different Business Structures
If you are starting or restructuring a business, you need to give careful consideration to the potential implications it can have for your business and for you personally. A business formation attorney can walk you through the potential tax implications resulting from various different business structures so that you can make an informed decision about which structure makes the most sense for you.
Sole Proprietorships
A sole proprietorship is when someone goes into business for themselves without creating a separate business 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
A partnership is a business structure that involves two or more people engaged in a single business. 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 that is owned by spouses in a community property state such as Texas may be taxed as a disregarded entity, similar to a sole proprietorship. 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 are separately taxed entities, meaning they will be taxed at the corporate level. Shareholders of the corporation will also pay income at the personal level on any income received from the corporation, including stock 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
Understanding the potential tax consequences of your new business is an important factor in how you choose to proceed. 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.