Use You Refund Check to Start Your Own Business, the S Corporation will avoid double taxation

Now that tax season is officially closed, it’s time to put 2012 behind us and focus on 2013. Put that refund check to good use and invest it in your future!  Start a business so you can put that 9-5 cubicle rut behind you and be an entrepreneur who makes your own schedule!

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The C Corporation

A C Corporation is considered a separate business entity and files its own tax returns. Therefore, as a C Corporation owner, you’ll need to file both a personal tax return and a business tax return.

Let’s say you own a small digital media agency and formed a C Corporation for it. Your Corporation will first be taxed on its profits in its corporate tax return. Then, if you want to take that money home, you’ll need to distribute it to yourself (or any other shareholders) in the form of a dividend. These dividends will be taxed on your personal tax return at the qualifying dividend rate. This is what’s known as “Double Taxation” and can be pretty hefty for the small business.

The Bottom Line: As you can see, double taxation can be a problem for a small business that is profitable and where the owner wants to put the profit in his or her wallet. However, the C Corporation can offer more flexibility and tax benefits in certain circumstances. For example, it can be a good structure if you want to invest the business’ profit to grow the business. Talk to your tax advisor before forming a C Corporation to make sure it’s the right entity for you.

The S Corporation

Small businesses often opt for the S Corporation in order to avoid double taxation. An S Corporation does not file its own taxes. Rather, company profits are “passed through” and reported on the personal income tax return of the shareholders.

S Corporation owners are taxed on the company profits based on the percentage of shares they own (for example, if you own 50% of an S Corporation, you’ll be taxed on 50% of the profits). If S Corporation owners actively work in the business, the business must pay them a reasonable wage for whatever job they do.

If you elect S Corporation Status for your corporation, your business itself will pay no income tax. If you work in the business, you need to pay yourself a reasonable wage for your job and these wages are subject to your personal income tax rate. Then if you decide to distribute the rest of the profits to yourself as a dividend, these will be taxed at the qualifying dividend rate.

The Bottom Line: The S Corporation avoids the problem of double taxation, but still demands all the legal formalities of a Corporation. It can be beneficial for many small businesses, but there are some restrictions for who can form an S Corporation. An S Corp cannot have more than 100 shareholders. All S Corp shareholders must be individuals (not LLCs or partnerships) and legal residents of the United States.

The LLC

The Limited Liability Company (LLC) offers flexibility when it comes to federal tax treatment.  That’s because the LLC is an entity created by the states. The IRS allows the LLC to be taxed as a corporation or sole proprietor, depending on what the LLC members choose.

For example, you can choose to structure your LLC as a single-member disregarded entity and it will be taxed like a sole proprietor. Or you can structure your LLC to be taxed like a C Corporation or S Corporation.

The Bottom Line: The LLC can be a good choice for small business owners who want liability protection, without all the procedural formality associated with a Corporation. An LLC gives you flexibility in terms of taxation – but after forming an LLC don’t forget that you need to decide how your business should be taxed.
In summary

There’s no single “right” business structure for every small business. What’s right for you will ultimately depend on your specific business needs, circumstances, and future plans. Discuss your particular situation with a trusted tax advisor or accountant in order to decide what business structure will give the best tax treatment for both you and your business.