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Business Year-end Tax Tip: Entity Consideration

Year-end is a good time to consider if the business entity you’ve chosen makes the most sense for your company going forward.

Did you know that 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.

Wages paid to an S corporation owner that are considered “reasonable compensation” may be less than a share of partnership ordinary income. This would lower the potential tax on self-employment income. The balance of the profit could be distributed by the S corporation and will not be subject to the FICA tax on income.

Following are some advantages and disadvantages for the various entity choices.  Davis & Hodgdon Associates CPAs has been assisting business owners with tax savings strategies for more than 25 years. Call our office at (802) 878-1963 in Williston, Vermont or (802) 775-7132 in Rutland, Vermont for more information and to schedule a strategy session.

We highly recommend having a year-end projection completed to ensure that you are in the best possible position for your 2016 return(s).

Sole Proprietorship:

  • Has no formal legal requirement for establishment
  • Owner has unlimited personal liability
  • Difficult for the sole proprietor to borrow or raise additional capital from outside sources
  • Because the sole proprietorship and its owner are one in the same, there is no tax upon the creation of the business.

LLC / LLP

  • Limited liability company
  • Limited liability partnership
  • May elect to be taxed as any of the other entities

Partnership

  • Partnership is an association of two or more persons to carry on a business as co-owners
  • Taxation of the operations of a partnership is generally considered an advantage if the partnership is passing through losses, deductions, or credits which may be used by the partners to offset other income and tax liabilities
  • Partnership is perceived to be desirable because it can be easily organized and the partners are not required to enter into a formal partnership agreement
  • Partnership is an association of two or more persons to carry on a business as co-owners
  • Taxation of the operations of a partnership is generally considered an advantage if the partnership is passing through losses, deductions, or credits which may be used by the partners to offset other income and tax liabilities
  • Partnership is perceived to be desirable because it can be easily organized and the partners are not required to enter into a formal partnership agreement
  • Disadvantage is the unlimited personal liability of the partners.
  • If the partnership is generating income, the income is taxed to the partner whether the partner receives a distribution of the income or not.

C Corporation

  • Business entity ranging in size from one-person operation to a large public corporation
  • Generally is the entity choice for most large businesses
  • Corporations can sell stock to raise additional capital to fund the business
  • Shareholders receive earnings in form of dividends, salary, rent, or other form of payment.
  • Largest disadvantage is the double taxation – taxation of the income at the corporate level and the taxation of dividends at the individual shareholder’s level
  • Double taxation also occurs upon liquidation or sale of all assets.

S Corporation

  • S Corporation provides the protection afforded by the corporate form without the disadvantages of corporate double taxation
  • To qualify as an S Corp: cannot have more than 75 shareholders; shareholder must be a U.S. citizen or resident; can only have a single class of stock.

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