Entrepreneurs have innovative ideas and a passion to get those ideas for inventions or services out into the public. When done wisely, this process can not only make the community a better place but can also lead to financial gain for the innovator behind the idea.
One step towards doing this wisely: choosing the right business structure.
What types of business structures are available?
There are many. One of the most well-known and complex is the corporation. A corporate structure essentially creates an entity of its own. The Internal Revenue Service (IRS) views this structure as its own entity, subject to taxation just like any other taxpayer. Business owners may choose this option because one of the primary benefits is protection. Since it is its own entity, if anything goes wrong and there is a lawsuit that lawsuit is generally against the corporation itself — not the innovator behind the idea.
There are particular rules to follow in the development of the structure that help ensure it will survive a legal challenge, best left for another post. The important part of this discussion is the taxation side of things. The IRS cares about the structure that the innovator chooses because it will impact tax liability.
How does business structure impact tax liability?
As discussed above, the IRS taxes corporations as their own entities. The owner’s earnings are taxed separately. Business owners and tax professionals often refer to this system as one of double taxation. It can be a downside to this business structure. However, depending on your goals, the benefits may outweigh this potential negative.
Other common business structures and their tax process include:
- Sole proprietorship. This involves one owner and is generally automatically present. As a result, it is the easiest to establish and most common. When it comes to taxes, the business is taxed directly through the owner.
- Partnership. Similar to a sole proprietorship, the taxes go through the owner. The primary difference is that a partnership normally involves more than one owner. Each is generally equally responsible for the business’ tax obligations.
- LLC. A Limited Liability Company (LLC) is the first step towards asset protection. It serves as its own entity for liability purposes. The entrepreneurs behind the LLC, referred to as members, are taxed in a manner similar to sole proprietorships.
These are just a few options to consider when looking to start a business. It is also important to note that additional discussions about the impact of state tax obligations are wise.
Which is right for my business?
It is important to carefully consider tax implications before choosing a business structure as the right structure will vary depending on the business owner’s goals. The attorneys at Goldburd McCone are familiar with these discussions and can aid in the due diligence process to help better ensure you understand the risks and benefits with each choice.