The Impact of Business Structure on Taxes: What Entrepreneurs Need to Know

As a business owner, you have multiple structured choices to select and begin your entrepreneurial journey. The Inc., LLC, or any other structure term you see attached to any business isn't just for fancy-sounding purposes. These structural additions have their implications for the company, and one such is the tax implications. For example, under the Tax Cuts and Jobs Act, owners of partnerships, limited liability partnerships, sole proprietorships, S corporations, and limited liability companies taxed as partnerships may be eligible to deduct up to 20% of their business income under Section 199A. This deduction began in 2018 and is valid through 2025 unless it is extended or otherwise noted.

Not every entrepreneur, like you, who is just beginning their business journey, will have insight into the tax obligations of the business structure they are registering. Having a basic understanding of different types of taxes will help you make informed business decisions, especially in the financial area.

Understanding the Impact of Business Structure on Taxes

Every business structure has different tax obligations, and the best choice will vary depending on the type of business, liability issues, and financial objectives. We have listed some tax implications of the most popular business structures:

Limited Liability Company (LLC)

LLC is a business structure in which each partner's legal liability is typically restricted to the amount invested in the business. If the partnership fails, creditors are often unable to seek the partners' assets or income. Under this form, a single-member LLC is taxed as a sole proprietorship, whereas multi-member LLCs are taxed as partnerships. This lets revenues go directly to owners, eliminating the double taxation standard in corporations.

If you are considering opening your company in Arizona, you will have a better legal picture. The requirements to form an LLC in Arizona are simple, making it an appealing option for small and medium-sized enterprises wishing to reduce tax liabilities without costly structuring.

Sole Proprietorship

A sole proprietorship business is where you own an unincorporated business by yourself. In this case, there is no separation between the company and its owner, so the owner has all the rights towards earnings. However, you will also be the one to face the liabilities and losses.

Since a sole proprietorship's business income is included directly on its federal income tax return, the owner has no separate tax obligation for the business. Instead, the owner will use its personal federal income tax rate to pay taxes on its business profits.

Partnerships

A partnership is yet another type of business structure in which two or more people are involved in running the business. They are equally responsible for sharing loss and profit. Partnership structure is further divided into general partnerships, limited partnerships, and limited liability partnerships (LLP). Since you are running a partnership business, you are eligible to avoid corporate tax rates. However, each partner will need to pay self-employment taxes.

Since a partnership can emerge without formal documentation when two or more people engage in a trade or business jointly to make a profit, you should connect with legal and tax counsel if they believe they may be engaging in a partnership.

Corporation

The corporation's business structure is divided into two types: C-corporations (C-corps) and S-corporations (S-corps). If you run a C-corporation, you are entitled to pay double tax, while S-corporations have a pass-through taxation policy for shareholders to avoid double taxation.

Conclusion

As an entrepreneur, choosing the best business structure is important to ensure you have insight into legal challenges and tax implications. It is best to connect with a tax advisor who can help you understand the unique requirements of your state and industry. With the correct structure, business owners can lower their tax loads, preserve their assets, and lay a more solid financial basis for future growth.