Understanding the tax implications of business formation

Understanding the tax implications of business formation

On Behalf of | Apr 27, 2022 | Uncategorized |

People who are starting up a new business have a lot of decisions to make about their product or services, their customers and business partners, their employees and many other things. But it’s crucial that they also take some time to decide which legal format they will use when they register their business entity. The wrong decision can lead to trouble down the road. The right decision can put the business on a foundation that will help it grow and thrive in the years to come.

When deciding on a business entity, business owners should take into account tax consequences, personal liability, the level of control the entity type allows the owner and the cost to run the business, among other factors. There are several primary business forms including sole proprietorships, partnerships, limited liability companies and corporations. There are also different types of corporations to consider. Each has its own implications for taxation and liability.

Pass-through taxation

In terms of tax treatment, sole proprietorships and partnerships are considered pass-through taxed. This means that the sole proprietor and partners are taxed for the income of the business on their personal tax returns. Corporations are somewhat different, as are limited liability companies, but elections for certain taxation treatment can be made.

Corporations can be taxed differently. A C corporation is sometimes referred to as double taxed because the corporation’s income is taxed and shareholders are also taxed on the dividends they earn or stocks they sell. An S corporation, on the other hand, enjoys pass through taxation like sole proprietors and partnerships, however, they are subject to certain limits including the number of shareholders which can limit growth. Limited liability companies can make an election whether to be taxed as a corporation or partnership.

These are important considerations and the tax ramifications associated with the business formation process should not be overlooked. For that reason, it is helpful for new business owners to be familiar with their options and what they mean for their business.