Are you starting a new business? Which entity should you choose?
If you are starting a new business, there are many things you have to consider. One, in particular, is understanding what entity is best for your business.
But first things first.
Understanding limited liability companies (LLCs)
Many people confuse protecting their company with how their business will be taxed as an entity. Remember, these are two different things!! If you want to protect your business, you should consider creating a liability limited company (LLC) for your business. By doing so, it protects the members or managers’ assets in the event of a lawsuit.
Just as the name implies, it provides limited liability. Also, it separates its owners from the business itself. Changing your entity into a limited liability company is a simple process. In many instances, most states require simply filing the Articles of Organization and paying a nominal fee. It is a good idea to speak with an attorney regarding whether an LLC would be best for your business.
How are LLCs taxed?
One of the biggest misconceptions concerning LLCs is the way it is taxed. For federal tax filings, an LLC may choose how they want to be taxed. The IRS automatically classifies each LLC to its default filing. For instance, the IRS automatically classifies a single-member business as a sole proprietorship. Also, the IRS classifies a business with two or more members/managers as a partnership. However, a company can choose a different tax entity to meet its needs.
Therefore, a sole proprietor can choose between a tax entity of a corporation, s-corporation, or sole proprietorship. A partnership (an LLC with two or more members/managers) can choose between a tax filing entity as a partnership, s-corporation, or corporation. To change from the default entity, an LLC is required to file form 8832 or form 2553 (to request to be taxed an s corporation).
How to choose?
Your ultimate goal should be to reduce your tax liability and choose the entity that would do just that. Tax planning is the best way to determine which tax entity works for your business. Consider running an analysis for your business using the desired entities or meeting with a tax professional and having them do it for you.
Make sure to provide prior-year tax returns and expected income and expenses for the current year to determine what works best. Remember, you want to ensure you are reducing your tax liability and maximizing your tax savings.