How does your business structure affect your business taxes?

Most large U.S. companies are structured as corporations, which are separate legal entities from their owners [source: McGraw-Hill Higher Education]. They are also separate tax entities: To the IRS, the corporation is a person to be taxed like any other person. In terms of tax filing, this means a lot of complicated paperwork, and owners often shell out cash to have tax pros deal with it. This can be a significant expense.

Even more significant, in terms of business income tax, it means profits are often taxed twice.

Since the business is a tax entity unto itself, it pays its own income tax on any profits it earns. Then, when those profits are distributed to shareholders as dividends, those shareholders pay income tax on it through their individual tax returns. This double taxation is one of the main tax drawbacks to the corporate business structure.

On the upside, a corporation doesn't have to distribute every last penny. It's allowed to keep some of its profits in the company, typically (or ostensibly) to cover post-filing expenses or to put toward future growth [source: Laurence]. This can be a tax advantage: While that undistributed money is still taxed a second time, it's taxed at the corporate income-tax rate, which is often lower than the owners' personal rates [source: Laurence].

To avoid double taxation on profits, and to reduce the (potentially expensive) complexities of tax filing, many smaller businesses choose to organize as one of the pass-through tax entities. Sole proprietorships, partnerships and S corporations are all pass-through entities; they and their owners are the same tax entity in the eyes of the IRS, so income tax is only levied once [source: SBA]. All profits "pass through" the business to its owners, who pay income tax on that money when they file their personal tax returns.

Pass-through entities can potentially save a lot when it comes to income tax. It's single versus double taxation. Easy decision, right?

Not always. Pass-through entities can get slammed when it comes to Medicare and Social Security.

In the United States, most businesses are pass-through entities [source: Tax Foundation]. And when it comes to income tax, "passing through" the profits is a huge benefit. In the case of the sole proprietorship or partnership, however, it has a significant downside: self-employment taxes.

Social Security and Medicare contributions, collectively known as employment taxes, are calculated based on a person's income. When you work for a company as an employee, your income is the wages you take home, and you and the company split the cost of your employment taxes [source: IRS]. When you work for yourself, your income is your business's entire net profit, and no one is splitting anything [sources: IRS, Dratch].

Self-employment taxes can be a huge drain. For this reason, many self-employed small-business owners choose the S corporation structure. In essence, S corporations combine the income-tax benefit of passing through profits with the employment-tax benefit of being employed by someone else.

In corporations, both C and S types, owners also can be employees. The business pays them wages just like any other employees. And as employees, those business owners pay employment taxes only on their wages, not on their companies' entire profits [source: Piper].

This can mean significant savings. Self-employment tax is 15.3 percent for the 2015 tax year [source: IRS]. If a sole proprietor's business profits total $75,000 for 2015, he pays 15.3 percent of $75,000, or $11,475, for Social Security and Medicare.

If an S corporation brings in $75,000, and out of that $75,000 the owner pays herself a salary of $40,000, she pays 15.3 percent of $40,000, or $6,120. That's a savings of $5,355.

Of course, this may not work out to an overall savings of $5,355. Since tax filing is a lot more complex for an S corporation, the owner will be spending more time on tax paperwork, and time is money.

Ultimately, which structure is most beneficial depends on the specifics of the company and the corresponding minutiae of the U.S. tax code. But, in short: If you're mostly looking for tax simplicity, a sole proprietorship or partnership is a good bet. If you're mostly looking for tax savings and have fewer than 100 owners, an S corporation might be the right fit.

If you've got 1,000 owners, simplicity is probably not in the cards, and the S corporation isn't an option. C corporation it is.