Choosing the right sort of business formation is one of the most important determinations you will need to make when creating a small business. For many entrepreneurs, It often makes sense for entrepreneurs to create a limited liability company (LLC), S-Corporation or partnership. This is due to minimal expense, ease in setup, and various tax considerations.
All three of these entities are attractive due to being pass-through entities. This means income from the business ultimately ends up reported on one's personal tax returns.
Each of these sorts of entities also have their advantages and disadvantages:
- Partnerships: These are easy to setup, but there is also unlimited liability. The individual partners may end up being liable for lawsuits and debts.
- LLCs: These combine the limited liability aspects of a corporation with the pass-through tax treatment of a partnership. Still, there may be a certain setup and operation costs associated with an LLC that do not come with a partnership.
- S-Corporation: It operates like a partnership, but has the legal protections of a corporation. However, it also requires more compliance with accounting and legal standards.
The new tax law and other tax considerations
While pass-through taxation means paying income taxes at personal rates, it can sometimes reduce the tax burden by avoidance of double taxation. Also, under the Tax Cuts and Jobs Act of 2017 (TJCA), there are a number of provisions that some commentators feel will be beneficial to pass-through entities.
The TJCA reduces income earned through a sole proprietorship, partnership and an S corporation from the personal rate of 39.6 percent to 37 percent. A new portion of the Internal Revenue Code also provides a significant deduction for qualified business income for such individuals.
While potentially beneficial, the TJCA does not necessarily make filling tax returns any simpler. Defining what is qualified business income as well as understanding the limits to this deduction is extremely complex. (The treasury department may yet provide certain interpretations of the new tax law.)
Also, New York also has its own set of laws concerning taxing of business income. In fact, there are a number of state proposals that could bring even more complexity into the mix.
It is important to understand that how you make your income may play a large role in determining how much tax your company will have to pay.
Weigh your options carefully
Figuring out what sort of business entity to set up and how to take advantage of tax breaks and deductions requires careful consideration. This may require the services of attorneys who understand how LLCs, S-Corps and partnerships operate, and who can speak to you about the advantages and disadvantages of each sort of pass-through entity.