Get guidance from a CPA on business structure, protections, and pitfalls.
Business Entity Registration, Formation and Filings
Weighing the pros and cons of different business types for tax purposes is a complicated and can make your head spin. Moxy is here to help you make that decision based on where you’re at and where you want to go.
Once you choose the type of entity that is the best fit for your business, you want to make sure you’re following the tax rules and regulations associated with that business structure.
Some helpful definitions and guidelines for entity selection:
Every business and situation is different: these guidelines and generalizations about tax entities are only intended to give you an idea of where to start asking questions. To learn more or to discuss your particular situation, schedule a consultation.
Sole-Proprietor / Self Employed / Side Hussle / Single member LLC’s:
People who are self-employed don’t need to do anything more than keep track of their income and expenses and add a Schedule C to their personal 1040 tax return.
Pros: Simple to form; Simple to report on a tax return; Simple to manage (it’s just you!)
Cons: Can get into arrears quickly with taxes if quarterly estimates aren’t made; Folks tend to spend almost everything they earn, so saving for taxes can be a challenge
Sole Proprietor’s are responsible for paying Federal & State income tax plus self-employment taxes on all their taxable net income. If not properly planned for, that can be a crushing tax bill when April 15th rolls around. To avoid an unmanageable tax burden and to stay compliant, the IRS requires self-employed folks to pay estimated quarterly taxes. Deciding how much to pay each quarter is something we can assist you with. Remember to send payments to the state as well!
Partnerships / Multi-Member LLC’s:
It may go without saying, but Partnerships are 2 or more people coming together to form a business for profit. Partnerships need to file a separate business return, Form 1065 by March 15th of each year.
Pros: Easy to form; Allows for flexible ownership changes; Allows for different types of partners
Cons: Must file a separate tax return from its owners; All income is subject to self-employment tax; partners are not deductible to the business (no payroll)
If you form a partnership, speak to an attorney to create an Operating Agreement for your business. This outlines the understandings you and your partners have about many business issues and clarifies your ownership percentages. Partners receive a K-1 from their partnership tax return (NOT a W2). The K-1 represents their percentage of the business income and any stand alone deductions that will be reported on their personal tax return.
Because the obligation to pay taxes passes through the Partnership and onto each partners personal tax return, they will want to pay estimated quarterly taxes to keep ahead of the yearly tax bill.
An S-Corporation is the lovechild of a C corporation and a Partnership. It’s still a “pass-through” entity for taxation (like a Partnership) but allows for the Shareholders providing services to the business to be on payroll (like a Corporation). Thus, shareholders on payroll are deduction to the business and lower the tax burden for everyone involved. A big win-win!
Pros: Shareholders can have a paycheck and a non-taxable way to take distributions from the business depending on how much they put in and how much business income has “passed through” to them in prior years (called Basis). Income “passed through” to the Shareholder is often eligible for the new 199A deduction.
Cons: Must file a separate business return, a 1120S, from its owners; Requires separate recordkeeping and contemporaneous documentation of business activities from owners. Distributions can only be distributed based on the percentage of ownership each shareholder holds. Lastly, shareholder on payroll requires the additional expense of using a payroll company.
This type of entity must be created with the IRS, filing two forms (form 8832 and 2553). You have to elect first to be a Corporation and additionally, an S-Corp. This two step process can be a real issue if you (or your attorney making the election) don’t know about it….so make sure to bring it up!
In short, we like this choice of taxation structure for MANY businesses, once you get to an appropriate level of income to offset the Cons.
S-Corporations are smart for businesses with employees, and mean the owners labor is a deduction to the business. But don’t forget that this structure is a bit more robust with rules and compliance requirements…plus you must pay for payroll processing.
There is still an obligation to pay Income taxes (only) on the income that passes through the S-Corporation and lands on owners personal tax returns, so paying estimated quarterly taxes to keep ahead of the yearly tax bill is still a requirement.
C-corporations are the OG corporation. They are the default type of entity when you set up a corporation…so beware, if you want an S-corporation you need to do some more work! When you have a C-corporation, you have created something that has its own tax obligations and identity. These are stand alone businesses that pay their own tax and report their own operations without much direct relationship to who owns them. They can be better vehicles for raising capital or having a LOT of people own the business however, they have severe restrictions on how money flows out of them and into them.
Pros: Totally separate from owners, can have lower tax rates, might be better for raising venture capital, can have an unlimited number of Stockholders and multiple types of stock, can have foreign investors.
Cons: Double taxation on money taken if not on payroll, Strict corporate governance laws, must pay and estimate taxes before dividends issued.
When you need a C-corporation, you kinda need a C-corporation but they can be very rigid and unwieldy to start your business in. Many industries (Software, Tech, Banking) use this as the go to business structure because their industry either expects it or demands it. If you want to go public or raise a lot of other-people’s-money to fund your venture, you would probably be best served in a C-corporation. The nice thing about having different types of taxation structures available is that you can “move up” as your business and fiscal literacy advance. You can always get to having a C corporation, but in my opinion they are not the default place to start for most businesses.