Taxation and management overhead dictate the choice of business structure. The latter includes, in increasing order of complexity, Sole Proprietorship, LLC, S-Corp and C-Corp.
The simplest corporate structure is Sole Proprietorship for which the only paperwork required is capturing your business revenue and expenses in Schedule C. However, this structure offers no separation between personal and business liability, thus exposing all personal assets to a potential lawsuit. The three other corporate structures, in their increasing order of complexity are LLC, S-Corp and C-Corp.
The first three corporate structures summarized in the table have a pass-through taxation, which means that net business income is taxed at your individual tax rate. Just as income is passed through to the owners, so too is an important deduction called QBI (Qualified Business Income) which allows up to 20% of your net business income to be deducted from AGI. This new significant deduction provided by the TCJA law is illustrated with examples in our blog “Pass-Through Deduction.”
A C-Corp is subject to double taxation because income is first taxed as a corporation at 21%, and then when the retained earnings are distributed as dividends to its shareholders, it is again taxed at the individual tax rate.
A LLC is not a tax entity and has to be taxed either as a S-Corp or C-Corp. An S-Corp has a tax advantage over Sole Proprietorship because part of the income, Unearned Distribution, is not subject to the Self-Employment tax of 15.3%. This concept is explained with an example in our blog “Taxation of Sole Proprietorship vs. S-Corp.”
LLC, S-Corp and C-Corp may each also have to pay a State tax. The table shows California State tax rates for these corporate structures. These corporations are also required by the IRS to file the appropriate Federal tax forms and provide a K-1/W2/1099 to their members, shareholders or employees to document their respective compensations.
The LLC, S-Corp and C-Corp structures also have detailed start-up procedures and management upkeep with which they must comply. These compliance procedures get more stringent as the corporate structure gets more complex.
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