The shape of your business affects your future and when I’m talking about the “shape,” I of course am referring to your Indianapolis business entity type.
Did you know that you CAN change that after the fact? Depending on which entity you are switching to, the process can be painful … but you are NOT “locked-in” to a particular entity for the entire life of your business.
It’s worth being very thoughtful about all of these things, especially as we deal with an inflationary environment that may (or may not) affect you in significant ways.
And yes, I saw the passage of the infrastructure bill the other day. Once the thing is signed into law by the President, I’ll dig into it a little more and give you my thoughts.
And before I dive into entity topics, you are invited to grab a time to talk about your Indianapolis business before year-end to ensure that we are capturing every available tax-savings strategy for you.
Find us here: helmscpa.com/book-an-appointment/
Ok, let’s talk business entity types. Nerds of the world, rejoice.
(TL; DR? — We can help you make sure you have the RIGHT entity for tax considerations and for your future plans.)
J.R. Helms & Associates, P.C.’s Rundown of the 5 Basic Business Entity Types
“Definiteness of purpose is the starting point of all achievement.” – W. Clement Stone
The classification and type of business you have is an “entity.” Different business entities get different tax treatments (nothing’s ever simple, right?).
For instance, in many circumstances, people in some partnerships, LLCs and S corporations (keep reading) can take a 20% tax deduction on their “qualified business income” (QBI). As always in taxes and business, conditions apply – and Congress is considering tweaking this break, so stay tuned.
It’s one example of how the right business structure can change your tax life.
Here are some of the most common entities and their good and bad points along with some very basic tax info:
Business Entity Type #1 – Sole proprietorship: This is the simplest biz structure. It’s just you. You get all the profits, take all the chances, and take all the hits.
You pay your regular income tax on the profits, but you also have to pay self-employment taxes. Paying these every quarter is a really good idea, no matter what business entity you have, to stay on the taxman’s good side.
Business Entity Type #2 – Partnership: This is a bit more formal than just a few sole proprietorships glued together to share expenses, especially when you’re talking about taxes.
You have to get an employer identification number from the IRS and register for all state taxes (think “sales tax”). You file a federal Form 1065 “information return” to report the income, deductions, gains, losses, and so on.
You also have to think about excise taxes and employment taxes; these tend to pop up no matter the business entity you use.
You pay income tax as an individual since the money you make (or lose) “passes through” to the partners. That’s you. Your business doesn’t get taxed separately.
Business Entity Type #3 – LLC: A “limited liability company” is easier to start and run than a corporation but provides owners and their personal assets (your bank account, car, home) “limited liability” for problems the company might get into. Profits or losses pass through to your personal tax return using a federal Schedule C or Form 1065.
Aside from you possibly being able to use that QBI deduction we mentioned, LLCs can be taxed as sole proprietorships or partnerships – but you can choose to be taxed like a corporation with the plus of paying taxes on the business profits at the (lower for now, anyway) corporate tax rate.
Two of the most common corp structures are S and C. They resemble each other, but there are big tax differences.
Business Entity Type #4 – C corp: Among other goodies, tax-free and tax-deductible benefits are available to employees in a C corporation (but as always, check with us on this), and owners can sometimes even get out of capital gains taxes when they sell a certain stock of the company.
But C corps suffer two levels of tax: On the income earned by the business and on the earnings distributed to shareholders as dividends. The individual shareholders must report this income on their individual tax returns. Dividends also get a really nice tax rate compared with income (but still, ouch).
Don’t be in a hurry to go to C: A recent study found that some startup C corps would have actually saved themselves money if they’d formed as LLCs.
Business Entity Type #5 – S Corp: These puppies pay only one level of taxation and a lot of C corps switch to S corp status. Tax bills can be like that…
S corps pass corporate income, losses, deductions, and credits through to shareholders who report the “flow-through” of income and losses on their personal tax returns – so S corps avoid that double taxation. They also get a real tax spark by only having to pay FICA taxes on salary compensation to owners and not on the remaining profits that magically transform into “distributions.”
Before you get visions of fattening your distributions, paying yourself a goose egg in salary, and dodging FICA altogether, the good folks at the IRS say that S corp owner-employees must be paid “reasonable compensation” for their services to the business.
Finally, there are a lot of conditions to qualify for S corp status and some states also have special rules for S corps.
You should never let the tax tail wag the dog of your Indianapolis business, and there’s a lot more to know about biz entities and their plusses and minuses. If you want to learn more, make some time to chat.
To your business being in optimum “shape” …
John R. “Rusty” Helms, C.P.A., CGMA
J.R. Helms & Associates, P.C.