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Small Business Tax Preparation

Tax Benefits of Incorporating

Tax implications are among the most important factors to think about when deciding on a business entity type. Some business owners are attracted to the simplicity of pass-through taxation, which is how a sole proprietorship, partnership, LLC, and S Corporation are taxed. But for others, the tax benefits of incorporating as a C Corporation offer more financial advantages.

What’s right for your business? We encourage you to ask that question to an experienced business accountant or tax advisor who understands your situation and can give you professional tax advice tailored to your circumstances and goals. As you prepare to start a business or convert an existing business, below is some general information about how corporations are taxed and some of the potential tax benefits of incorporating a business.

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Tax Advantages for Business Entities

Let’s now take a look at the potential tax benefits of each entity type
C Corp structure

Tax advantages of the C Corp structure:

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Corporate Income Tax Rate Maybe Favorable

A C Corp’s profits get taxed at the corporate income tax rate. In some circumstances, that might work in the business owners’ favor. Depending on the location and shareholders’ personal tax situation, they might find the corporate tax rate will cost them less than if they were set up as a pass-through entity (LLC, partnership, or sole proprietorship).

More Tax Deduction Opportunities

As a C Corp, the business may be eligible for more tax deductions than if it were an LLC, partnership, or sole proprietorship.

S Corporation Options for Qualifying C Corporations

Eligible C Corps may be taxed as an S Corporation, enabling them to avoid the sting of “double taxation.

Pass-Through Taxation

Single-member LLCs are taxed as sole proprietorships, and multi-member LLCs are taxed as partnerships by default. Therefore, they provide simplicity (and possible cost-advantages, depending on individual income tax rates) of pass-through taxation.

Tax flexibility

LLCs that meet the IRS’s eligibility requirements may elect to be treated as an S Corporation for income tax purposes. This may reduce the LLC members’ Medicare and Social Security tax obligations because only the owners’ salaries and wages are subject to those taxes (profit distributions are not).

Flexibility when distributing profits

LLC members choose how the LLC will divide company profits and losses among its owners. This enables them to consider not only the money invested but also the time and work invested when distributing profits.

LLC Structure:

Tax advantages of the LLC structure

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S Corp structure

Tax advantages of the S Corp structure:

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Lessens the Self-employment Tax Burden on LLC Members

As I mentioned earlier, eligible LLCs may elect to be taxed as an S Corp. What’s the advantage of that? Only income paid to LLC members on the payroll is subject to self-employment taxes. Profits paid as distributions are not subject to Social Security and Medicare taxes, so LLC members may find that the S Corporation election lowers owners’ personal tax burden.

Enables C Corporations to Avoid Double Taxation

As an S Corporation, a corporation’s profits and losses flow through to shareholders’ personal tax returns and are taxed at individual tax rates. The corporate entity does not pay income tax. Shareholders that are employees of the C Corporation only pay self-employment tax on the wages or salaries that the corporation pays them. Dividend income paid to shareholders is not subject to self-employment tax; those monies are taxed as either ordinary income or qualified dividends.

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