Reforming How We Choose Our Business Entity
As we chug along into the new year and the tax deadline is rapidly descending upon us,
you may be hearing from your various business advisers why you should choose one entity over another, with the new year. The problem is, at this particular moment, you are far more concerned with what happened in last years taxes, to be further inundated with information on how the new reform will affect your business, or how to choose best for the upcoming year. So, allow me break it down a little more and give you a chance to digest some of this information before you meet with your adviser and go into “analysis paralysis”.
If you’ve started a new business, you may be curious how to choose best—for good reason. Choice of entity is a critical decision with various tax and non-tax considerations, that can drastically affect your overall business plan. As I’m sure you’re well aware, choosing a business ‘entity’ simply means, declaring to the public and the government what the structure and operation of your business will look like.
Don’t be deceived by the fact that you can count the number of entities to choose from on one hand, and take this decision lightly—it’s important to make the right choice the first time, because it is difficult to reorganize or adjust your plan later.
Before going into which entity is right for your business, the very abbreviated IRS definitions of each of these 5 entities will provide a useful reminder and context:
- Corporations: prospective shareholders exchange money, property, or both, for the corporation’s capital stock.
- Sole Proprietorship: someone who owns an unincorporated business by himself or herself.
- Partnerships: is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.
- S Corporations: are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.
- Limited Liability Company (LLC): is a business structure allowed by state statute. Owners of an LLC are called members. Most states do not restrict ownership, and so members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Most states also permit “single-member” LLCs, those having only one owner.
In the past few months, we have heard nothing but, “tax reform, tax reform, tax reform.” Among other changes, one of the the most obvious reforms (specific to business entities) includes a significant reduction in corporate tax rates, where C-corps are now at a flat 21% tax rate—previously 35%. This change might encourage you and other entrepreneurs to organize your business as a C-Corporation, alternatively to an entity that is taxed on a pass-through basis. However, even with the tax reduction, there are significant reasons a business owner might still choose to form their business as a pass-through entity, rather than a C-Corp.
So, what is a “pass-through” you may ask. For example, income generated by a C-Corp pays a federal income tax when earned, and once again when distributed to its shareholders. This double dipping of taxation can make a C-Corp seem out of the question for some owners. For this reason—among others, some entrepreneurs choose to structure as a “pass-through” entity, like choosing a LLC or S-Corp. With entities like these, income is not double dipped with taxes. Rather, gains are “passed-through,” where business owners pay taxes on their portion of income directly.
Along the same lines of “pass-throughs,” there is also a new 20% pass through deduction for QBI-qualified business income, for partnerships, S corporations, and sole proprietorships. So what does that mean to you?
Basically, if your taxable income is less than $315,000 (married) or $157,500 (single), then the owner deducts 20% of qualified business income as determined by a per business basis.
These are just a few examples of how choosing a proper entity for the upcoming year can drastically affect your bottom line. There should always be a specific set of reasons a business owner chooses a particular entity. Allow us, at VB CPA, to guide you in your selection process with more details, specific to you and yours