The business form you operate in must fit your business needs. And, as your business grows or personal situation changes, so will your needs. Keep in mind that your decision will have an impact on the amount of tax you and your company will pay. There are distinct advantages and disadvantages of each form of doing business. So, whether you're a sole proprietor, C Corporation or S Corporation, Limited Liability Company, or a general or limited partnership, periodically review whether your current form of business is still best for you.

C corporations are taxed as separate entities and have certain tax obligations of their own. The corporation pays taxes, and you pay taxes as an employee. Investors are taxed on the dividends they receive. C corporations can offer more fringe benefits, but they also receive more IRS scrutiny. Salary paid to you and other shareholders must be reasonable or a portion of it may be reclassified as a nondeductible dividend payment. If earnings are accumulated beyond the reasonable needs of the corporation, an additional 39.6% tax will be imposed on these earnings.

S corporations are an advantageous entity option since they normally pay no tax and pass through income and losses to shareholders. S corporations may have up to 75 shareholders, which can be individuals, estates, certain trusts, and tax-exempt organizations.

S corporations are permitted to own any percentage of the stock of other corporations. And, if they own 100% of a qualified corporation, that subsidiary may elect "S" status. Please note that the qualified subsidiary is a disregarded entity for tax purposes.

If you're employed by your S Corporation, you and the corporation can avoid FICA taxes by minimizing your salary. However, if your salary is deemed to be unreasonably low, the IRS will try to attribute additional salary to you. Plus your future social security benefits may be reduced.

Partnerships, like S corporations, are popular because they avoid corporate double taxation. Limited Liability Companies (LLCs) and Limited Liability Partnerships (LLPs) offer many advantages. Taxed as partnerships, they allow many types of owners and provide limited personal liability.

Family limited partnerships can also offer a number of benefits. They may allow you to split income with your children, realize estate tax savings, and continue to keep effective control over assets you transfer to the partnership.

In a sole proprietorship, your personal return is your business return. But, if you risk substantial liability in your business, consider some form of incorporation, LLC, or LLP, to protect your personal assets.

Which is right for you? That's a decision made between you and your team of financial and legal advisers. And remember, you must consider state and local taxes when evaluating business structure. Call us to discuss your alternatives.

Tax Tip

Many states allow sole proprietors to form LLCs, which will limit their liability without the headache of filing a separate tax return.

Comparing Business Structures

Which One Is Right For You?

C CORPORATION
Tax Rates
Federal marginal tax rates from 15% to 39% with an overall maximum rate of 35%. Possibly taxed again at distribution. Shareholders pay tax on dividends. Losses do not pass through to shareholders.

Liability
Shareholders are shielded from personal liability for business debts. Only their investment is at risk.

S CORPORATION
Tax Rates
Generally, no federal tax on the business entity. Income and expenses are allocated among shareholders. Taxable income is subject to individual rates from 15% to 39.6%, whether profits are distributed or not. Losses pass through to shareholders. Restrictions on loss deductibility apply. State treatment of S corporations may vary.

Liability
Shareholders are shielded from personal liability for business debts. Only their investment is at risk.

GENERAL PARTNERSHIP Tax Rates
No federal tax on business entity. Income and expenses are allocated among partners and each pays tax of 15% to 39.6% (plus self-employment tax, if applicable) on their share of partnership profits whether distributed or not. Losses pass through to partners. Restrictions on loss deductibility apply.

Liability
Personal liability rests with each partner.

LIMITED LIABILITY COMPANY
Tax Rates
No federal tax on business entity. Income and expenses are allocated to "members" and each pays tax of 15% to 39.6% (plus self-employment tax, if applicable) on their share of LLC profit whether distributed or not. Losses pass through to members. Restrictions on loss deductibility apply.

Liability
Members are shielded from personal liability for business debts. Only their investment is at risk.