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Business Owners: Now is a Good Time to Review Your Choice of Entity

October 05, 2021

As we approach the end of 2021 this is a good time to consider the appropriateness of your entity structure to ensure it aligns with your needs and evaluate the possibility of changing your structure. 

Business structures differ mainly in how they handle income taxation and owner liability.  Many organizations choose a structure that combines pass through income taxation with limited liability for the owners—namely, limited liability companies or S-Corporations. 

The tax on self-employment earnings increases the Social Security tax burden on income from businesses organized as partnerships or LLCs treated as partnerships and sole proprietorships for federal tax purposes. Since all ordinary income generated and passed through to owners from an active trade or business under the partnership rules are subject to the self employment tax, utilizing an S corporation could minimize the impact.

At issue is how much of the company’s profit will be subject to self-employment taxes. As a partnership, the company’s profit is subject to self-employment taxes. However, as an S corporation, an owner must take “reasonable compensation” out of the company as W-2 wages which would be subject to payroll taxes, an equivalent of self-employment taxes. Any profit above these wages is not subject to self-employment taxes and are available to be taken out as distributions.

The TCJA drastically reduced the corporate income tax rate to 21%, which is significantly lower than the top individual income tax rate of 37%.  In certain cases, business owners may benefit from shifting their operations to a corporate structure.

With offices in Rutland and Williston, Vermont Davis & Hodgdon Advisory Group has served small- to medium- sized business owners for more than 30 years through expert staff, high-end technology, and unparalleled efficiency. Our mission as your accountant is to provide the financial peace of mind for yourself, your business, your children, and future generations.