There's nothing simple about starting and owning a business. Choices are everywhere -- in business plans, company names, pricing, employees, benefits and office space. But first, in order to register your company with state and federal agencies, you'll need to choose a business structure, and this choice can have ramifications that are not immediately clear.
A business's structure is basically the way it's organized. It answers questions like who's in charge, how profits will be distributed and whether owners are responsible for debts accrued by the business. The most common IRS-recognized business structures include the following [source: IRS]:
- Sole proprietorships, which have one owner. That owner takes home all of the business's profits as personal income. The company and the owner are the same legal entity; the owner is personally liable for any business debts.
- Partnerships, which are structured like sole proprietorships except with an unlimited number of owners.
- C corporations, which have an unlimited number of shareholders. Each shareholder owns part of the company. Profits are distributed (as dividends) among all owner-shareholders. C corporations and their owners are separate legal entities; owners are typically not personally liable for business debts.
- S corporations, which are structured like C corporations except that the number of shareholders is capped at 100.
Clearly, choice of structure affects how a business operates. Perhaps less clear, it also affects how much a business and its owners pay in taxes, sometimes dramatically so.
The U.S. tax code is quite detailed, and there are countless tax ramifications of selecting any particular business structure. But there are a few basic tax differences we can rely on to help us decide.
Federal business taxes break down into four main categories:
- Income taxes, which are taxes on a business's profit
- Employment taxes, which are employees' Medicare and Social Security contributions
- Self-employment taxes, which are self-employed individuals' Medicare and Social Security contributions
- Excise taxes, which are special taxes applied to particular products or services (such as tobacco, alcohol, gambling and some vaccines)]
Excise taxes, for one, are applied regardless of business structure. But for income tax and employment/self-employment taxes, how much businesses and their owners end up paying is directly related to structure.