What are the federal tax differences between different types of small business entities? In a prior post I discussed some of the different types of legal entities that a small business should consider. In this post I will discuss some of the tax differences of those entities:
Single Member Limited Liability Company: As the name implies, in a single member LLC, there is only one owner of the limited liability company. The entity (LLC) itself is not taxed. A federal and state Schedule C reports profits and losses to the single member.
Corporation: For tax purposes a corporation can be either an S-corporation or a C-corporation. In order to be an S-corporation, the corporation must file an “S” election with the IRS and the state.
S-corporation: The entity itself is not taxed, profits and losses pass through to the shareholders. his type of corporation is limited by the number of shareholders permitted and is not other limitations.
C-corporation: If an “S” election is not filed with the IRS, the corporation will, by default, be a C-corporation. A C-corporation is subject to double taxation – both the corporation is taxed and the owners of the corporation are taxed. Profits and losses are not passed through to the shareholders, but are taken by the corporation. This may be advantageous to certain types of businesses and is essential to any business formed using 401K or IRA roll-over funds to finance the business.
Multi Member Limited Liability Company: Like the single member LLC, the multi member LLC is not taxed separately for federal taxes. The LLC can choose to be taxed as a partnership or an S-corporation. Either way, all profits and losses pass through to the members.
General Partnerships: Not a recommended form of business ownership since there is no separate legal entity that shelters the individual owners unless those owners are limited liability companies or corporations. Profits and losses pass through to the partners.
Sole Proprietorship: Not recommended as a form of business for any business that could potentially have liability. No separate legal entity for the business so all obligations of the business are the liability of the individual owner of the business. The owner’s personal assets are at risk for any judgment or debt of the business. All profits and losses are the individual owners.
In the case of a corporation (S or C) and a limited liability company (single or multi member), maintaining the entity properly is essential to protect the owner’s personal assets from being used for any debts or judgments against the company.
This article is not intended to provide legal advice nor to create an attorney client relationship. For further assistance, please contact Spadea Lignana. at 215-525-1165.