Maximize Profits, Minimize Taxes: The Right Business Structure Matters

How Different Business Structures Are Taxed

1. Sole Proprietorship

Sole proprietors report business income and expenses on their personal tax return using Schedule C (Form 1040). Since the IRS doesn’t distinguish between the owner and the business, all profits are subject to self-employment taxes, which cover Social Security and Medicare.

Key Tax Considerations:

• Business profits are taxed at the owner’s individual income tax rate.
• Must pay self-employment tax (15.3%).
• Eligible for business deductions, including home office and mileage expenses.

2. Partnership

A partnership is a pass-through entity, meaning business income is reported on each partner’s personal tax return. Partnerships must file Form 1065 (U.S. Return of Partnership Income) and issue Schedule K-1 to each partner, detailing their share of profits and losses.

Key Tax Considerations:

• Partners pay income tax on their share of profits, regardless of whether they withdraw the funds.
• Subject to self-employment tax unless structured as a limited partnership.
• Pass-through taxation avoids double taxation at the business level.

3. Limited Liability Company (LLC)

An LLC offers tax flexibility. By default, a single-member LLC is taxed like a sole proprietorship, while a multi-member LLC is taxed like a partnership. However, LLCs can elect to be taxed as an S Corporation or C Corporation for potential tax advantages.

Key Tax Considerations:

• Pass-through taxation unless electing C Corp status.
• LLC members may be subject to self-employment taxes.
• May qualify for the Qualified Business Income Deduction (QBI) of up to 20%.

4. S Corporation (S Corp)

S Corporations are pass-through entities but offer tax advantages by allowing owners to pay themselves a reasonable salary while taking additional profits as distributions, which are not subject to self-employment tax.

Key Tax Considerations:

• Must file Form 1120-S and issue Schedule K-1 to shareholders.
• Owners must receive reasonable compensation, which is subject to payroll taxes.
• Shareholders are taxed on their share of profits at individual tax rates.

5. C Corporation (C Corp)

A C Corporation is a separate tax-paying entity, meaning it pays corporate income tax on its profits. If profits are distributed as dividends, shareholders pay taxes on those dividends, leading to double taxation.

Key Tax Considerations:

• Files Form 1120 (U.S. Corporation Income Tax Return).
• Subject to a flat 21% corporate tax rate (as of 2024).
• Dividends distributed to shareholders are taxed at capital gains rates.
• Eligible for a wider range of tax deductions and credits.