Tax Implications of Different Business Entities Explained

When starting or restructuring a business, choosing the right business entity is one of the most important decisions you’ll make. Each type of business entity comes with unique tax implications that can significantly impact your bottom line. At Edwards Law, we help business owners navigate these complexities to ensure their structure aligns with their goals and minimizes tax liabilities.

Here’s a breakdown of the tax implications for the most common business entities:

1. Sole Proprietorship

Tax Basics:
A sole proprietorship is the simplest business structure, where the owner and the business are legally the same entity. Income is reported directly on your personal tax return using Schedule C.

Tax Implications:

• Profits are subject to self-employment taxes (Social Security and Medicare), totaling 15.3%.
• All income is taxed at the owner’s personal income tax rate.

Best For:
Freelancers, independent contractors, and small business owners with minimal liability concerns.

2. Partnership

Tax Basics:
In a partnership, income “passes through” to the partners, who report their share of the profits or losses on their personal tax returns using Schedule K-1.

Tax Implications:

• Partners are subject to self-employment taxes on their share of income.
• The partnership itself does not pay federal income tax but must file an informational tax return (Form 1065).

Best For:
Two or more individuals looking to share profits, responsibilities, and tax burdens.

3. Limited Liability Company (LLC)

Tax Basics:
An LLC offers flexibility in taxation—it can be taxed as a sole proprietorship, partnership, or corporation.

Tax Implications:

• Single-Member LLCs are taxed like sole proprietorships, with profits subject to self-employment taxes.
• Multi-Member LLCs are taxed like partnerships unless otherwise elected.
• Electing S-Corp Status: LLCs can choose to be taxed as an S-Corp to save on self-employment taxes by paying owners a reasonable salary (subject to payroll taxes) and distributing remaining profits free of self-employment taxes.

Best For:
Business owners seeking liability protection with flexible tax options.

4. C Corporation

Tax Basics:
C Corporations are separate legal entities that pay taxes on profits at the corporate level.

Tax Implications:

• Profits are taxed at the corporate tax rate (currently 21%).
• Distributions to shareholders (dividends) are taxed again at the individual level, resulting in double taxation.

Best For:
Businesses planning to reinvest profits or attract investors.

5. S Corporation

Tax Basics:
An S Corporation avoids double taxation by passing income directly to shareholders.

Tax Implications:

• Shareholders report income and pay taxes at their individual rates.
• Avoids self-employment taxes on distributions, but owners must pay themselves a reasonable salary, which is subject to payroll taxes.

Best For:
Small to medium-sized businesses looking for tax efficiency and liability protection.

Choosing the Right Entity

Selecting the right business entity depends on:

• Your business goals.
• The size and type of your operation.
• Your desire to limit liability or minimize taxes.

Working with an experienced attorney ensures that your choice aligns with both your immediate needs and long-term plans.

Contact Edwards Law for Expert Guidance

Choosing the right business structure is critical to your success. At Edwards Law, we specialize in helping entrepreneurs understand the legal and tax implications of their options. Whether you’re starting a new business or considering a restructure, we’re here to help.

Contact us today for a consultation and let us guide you toward the best business structure for your needs.