When starting a business, choosing your business structure is one of the most critical decisions you'll face. While many entrepreneurs automatically gravitate toward forming an LLC (Limited Liability Company), this one-size-fits-all approach might not be optimal for your situation. Your choice of entity will affect everything from your tax obligations and personal liability to your ability to raise capital and plan for succession. Making the wrong choice could expose you to unnecessary risks or burden you with excessive taxes and administrative requirements.

Understanding Tax Implications Across Different Structures

Each business structure comes with distinct tax treatment that can significantly impact your bottom line. As a sole proprietor, for instance, all business income passes through to your personal tax return, where you'll pay income and self-employment taxes on your earnings. While this arrangement offers simplicity, it could come with an increased audit risk.

An LLC offers more flexibility in tax treatment than just defaulting to sole proprietorship/pass-through treatment. A single-member LLC can be taxed as a sole proprietorship, while multi-member LLCs can be taxed as partnerships. However, an often-overlooked option is to tax your LLC as an S Corporation, which can provide significant tax savings once your business reaches around $60,000 in annual revenue. With S Corporation tax treatment, you only pay payroll taxes on your actual salary, not on your profit distributions, potentially saving around 15% in payroll taxes on those distributions.

One crucial consideration with S Corporation tax treatment is the requirement for "reasonable compensation." The IRS requires S Corporation owners to pay themselves a reasonable service salary before taking profit distributions. What constitutes reasonable compensation can be subjective, but getting it wrong could result in serious consequences, including reclassifying all distributions as wages subject to employment taxes and potential penalties of up to 100%. 

Beyond Basic Liability Protection

While liability protection is often the primary reason entrepreneurs choose to form an LLC or corporation, each structure offers different levels and types of protection. For instance, professional corporations (PCs) can provide specialized protection for licensed professionals like doctors, lawyers, and accountants. Series LLCs allow real estate investors or entrepreneurs with multiple business lines to create separate "series" within one legal entity, each with its liability shield.

C Corporations, despite their reputation for complex administration and double taxation, can offer unique advantages for businesses generating significant profits because a C Corporation structure allows for sophisticated planning opportunities (the nature of which is outside the scope of this article, but book a call with me to learn more). The current corporate tax rate of 21% can also be advantageous for businesses reinvesting profits into growth.

However, C Corporations face double taxation, where profits are taxed first at the corporate level and then again when distributed to shareholders as dividends. This is why many smaller businesses opt for pass-through entities like S Corporations or LLCs, where profits are only taxed once at the individual level.

Making Your Decision with Growth in Mind

When choosing your business structure, consider where it is today and where you want it to be in five or ten years. Will you want to bring in outside investors? Are you building a company to sell or creating a legacy to pass down? Do you plan to expand internationally? These plans should heavily influence your choice of entity today.

For example, if you plan to seek venture capital funding, a C Corporation might be more appropriate despite its higher administrative complexity. Venture capitalists prefer C Corporations due to their flexible stock structure and familiar operating requirements. Or if you're a solo professional service provider expecting steady growth, an S Corporation election could offer better long-term tax advantages than a simple LLC.

Remember that certain structures have specific requirements that might affect your future flexibility. S Corporations must meet several criteria, including:

• Having no more than 100 shareholders

• All shareholders must be U.S. citizens or permanent residents

• Can maintain only one class of stock

• Must be a U.S. corporation

• All shareholders must consent in writing to the S Corporation election

• Shareholders must be individuals, estates, or certain qualified trusts

Additionally, consider the administrative burden each structure requires. While sole proprietorships and partnerships offer simplicity in formation and operation, corporations and S Corporations require more rigorous record-keeping, regular meetings, and documentation when choosing; factor in these ongoing requirements, as they represent both time and monetary costs to your business.

Finally, to maximize the benefits of the right business structure for your business, make your decision with your eyes wide open - educated about and aware of all available options. The stakes are too high to go at it alone; you need a knowledgeable, trusted advisor on your side.

The Advisor You Need When Decisions Matter

As your trusted LIFTed Business Advisor and attorney, I understand that choosing the proper business structure involves carefully weighing multiple factors, from tax implications to growth plans. That's why I offer a comprehensive LIFT Business Breakthrough Session™, during which we'll analyze your current and future needs to help you make the best choice for your unique situation. Together, we'll develop a plan that protects your business today and positions it for the growth and success you envision for tomorrow.

Contact us today!

This article is a service of Res Nova Law, a LIFTed Business Advisor and Personal Family Lawyer® Firm. We don't just draft documents; we ensure you make informed and empowered decisions about life and death, for yourself and the people you love. That's why we offer a LIFTed Business Breakthrough Session™, during which you will get more financially organized than you've ever been before and make all the best choices for the people you love. You can begin by calling our office today to schedule a Life & Legacy Planning™ Session.

The content is sourced from Personal Family Lawyer® for use by Personal Family Lawyer® firms, a source believed to be providing accurate information. This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal, or investment advice. If you are seeking legal advice specific to your needs, such advice services must be obtained on your own separate from this educational material.