Which entity offers the best tax advantages?
When starting a business, the most important decision that you need to make is choosing the legal form in which your business will operate according to your state’s requirements. Whether it is sole proprietorship, limited liability company, corporation, C Corporation or S Corporation, choosing the entity that offers the substantial benefits to your business is vital. And as your business starts growing, you may want to change the business entity to accommodate more owners, a diversified capital structure, or protect your growing assets from business liability. Make sure to weigh the tax considerations associated with the business type you choose in your state.
You have many options when it comes to incorporating a business, choose an appropriate one fulfilling your state’s requirements. Check out which of the following business entity offers best advantages in your state.
In this business entity, the business and the owner are legally the same. Once Sole proprietorship is established, taxes are filed through the owner’s personal taxes. However, there are severe tax limitations in particular situations. The rate for personal taxes is much greater than for a corporate entity, and even some employee benefits are not deductible. Besides, the owner assumes complete liability, including taxes. The business is not a taxable entity from the IRS’s perspective. Instead, in this business entity, all of the business liabilities, assets and income are treated as belonging directly to the business owner.
IRS issues a nine-digit number known as an Employer Identification Number or EIN. With this EIN, the IRS keeps track of the businesses in Nevada. Even some banks require EIN to open a bank account, and it can lessen the risk of identity theft.
Businesses are required to report taxes and file various employee reports. You may need to use your EIN when registering your business to report taxes through the Nevada Department of Taxation. If you have employees, you need to report and pay employment taxes on a regular basis. Depending on your particular business activities, you may be required to report and pay all the employment-related taxes with such items as sales tax and use tax through the Nevada Tax.
In Delaware, income from your business will be given to you as the sole proprietor. This income will be subject to taxation on your personal state tax return.
For instance, If your sole proprietorship has net income of $100,000. The $100,000 in net income is given to you personally, and you will have to pay tax on that income on your individual state tax return. Note that the rate will vary depending on your overall taxable income for the year.
Wyoming is considered as the most income tax-friendly state in the country. In Wyoming, sole proprietorships are subject to a state’s tax on personal income.
- Personal taxation: Profits are taxed as personal income on IRS Form 1040, Schedule C or Schedule C ‐ EZ, as well as Schedule F
and sometimes Schedule E.
- Self‐Employment Tax
- Estimated tax payments
- You will need to file on Form SS-4 for a “Federal Tax Identification Number” if you hire employees, you will be liable for any Federal Excise Taxes.
In most of the cases, a small business is structured as a sole proprietorship because it has the most straight forward setup and is the least expensive. Individual owners who don’t need investors for capital best fit into this category. From a tax standpoint, sole proprietorship makes sense if there are few or no employees and profits are limited.
As with the sole proprietorships, both the business and the owners are legally the same. There is no separate partnership income tax, as there is a corporate income tax. A partnership is not a taxable business entity under federal law. Income from the partnership is taxed to each partner, at their individual tax rates. For tax purposes, all the income of the partnership must be reported as “passed-through” or distributed by the partners, who will then be taxed on it through their individual returns.
In Nevada, most of the partnerships are considered pass-through entities. This means that the income from the company is passed through the owners’ personal income. In Nevada, there is no separate tax form required for partnerships.
General partnerships are required to pay a flat annual tax of $250 to Delaware. However, apart from this annual tax, income from partnerships is divided to the individual partners, who then, pay tax on the amount distributed to them on both their federal and state tax returns. The rate for each partner will vary depending on his or her overall taxable income for the year.
For instance: If you opt for general partnership in Delaware and your company has a net income of $100,000. The company will owe the state general partnership tax of $250. Beyond this, the partnership’s net income will be distributed between you and your partners, and each of you will pay tax on your particular portions on your respective state tax returns.
For Wyoming General Partnership, check the following tax implications:
- The partnership files IRS Form 1065.
- Individual partners pay tax: Each partner receives a K-1, mentioning the distributive share of partnership items to
be declared on partner’s 1040.
- Estimated tax payments: Partners may be subject to quarterly tax payments.
- Social Security: Partners may be subject to self-employment tax.
- A partnership needs to be filed on Form SS-4 for a “Federal Tax Identification Number.”
- If a partnership hires employees, it will be applicable for employment taxes.
If you are comfortable with pass-through entities and need the the freedom from a lot of rules regarding how the business should be named, ran, and maintained, no need for lots of complicated paperwork, you can consider general partnerships.
Limited Liability Company
LLC is a separate legal entity created by a state filing. Under the state laws, LLC owners are provided the liability protection that was earlier afforded only to owners of a corporation also known as shareholders. These days, LLCs are managed like partnerships for federal tax purposes until and unless they elect to be managed like a corporation, which most of them don’t. LLCs have “pass-through” taxation. It means that no tax on the LLC’s income will be paid at the business level. Income and profit/loss are instead reported on the personal tax returns of the owners, and any tax that is due is paid at the individual level. Note that even though LLCs are treated as partnerships for federal tax purposes, but the same is not always true for state tax purposes.
LLCs themselves are not taxed in Nevada. LLC members are taxed on the proportionate share of their LLC income, even if it is not distributed to them, at individual income tax rates. Nevada, however, levies no state income tax on either corporations or individuals, according to the Nevada Secretary of State website. Moreover, employer payroll tax is only 0.7% of the gross wages. There are no inventory or franchise income taxes.
Delaware LLCs are generally pass-through entities and are not expected to pay federal or state income tax. LLCs in Delaware are, however, required to pay a flat annual tax of $250 to the state. Apart from this annual tax, income from the business is distributed to each LLC member, who then pays state and federal taxes on the amounts distributed to them. Keep in mind that by default LLCs are classified as partnerships for tax purposes, it is permissible to elect to have your LLC classified as a corporation. In that case, the LLC would become subject to Delaware’s corporate income tax.
For instance: If your multi-member LLC has the default tax classification of partnership and a net income of $100,000. Clearly, the LLC will owe the state LLC tax of $250. Beyond this, the net income will be distributed to each LLC member, and each of you will pay tax on your own portions on your respective state tax returns. Note that the rate for each member will vary depending on his or her overall taxable income for the year.
For Wyoming Limited Liability Company, check the following tax implications:
- Get legal and accounting information from your attorney
- Check with your legal advisory whether you need to file form 1065 or 1120.
For a business that depends on a sizable workforce or has grown to have raised profits, the cost and extra paperwork of an LLC may be the wisest choice for tax purposes.
C Corporation is a separate legal entity formed by a state filing. The C Corporation is also referred as the “regular” corporation. It is subject to corporate income tax. The Income gained by a C corporation is usually taxed at the corporate level with the corporate income tax rates. C corporation income is also subject to “double taxation.” Double Taxation is when the income of the company is distributed in the form of dividends to the owners because dividends are taxable. Firstly, the tax is paid by the corporation on its income and then it is again paid by the owners on the dividends received. If the owner draws a salary from the corporation, that salary is also subject to income tax.
In Nevada, a C Corporation is taxed as a separate entity and is expected to report profits and losses on a corporate tax return. The C Corp is required to pay corporate taxes on its profits while the shareholders are not taxed on the corporation’s profits. When the corporation decides to pass along any of its after-tax profits to shareholders in the form of dividends, the shareholders are required to report those dividends as income on their personal tax returns even though the corporation has already paid corporate taxes. This is usually referred to as “double taxation.”
Delaware C corporations are subject both to its corporation income tax and the state’s franchise tax.
For Instance: If your Delaware C corporation has a taxable net income of $100,000, 10,000 authorized shares, assumed no-par capital of $100,000, and assumed par value capital of $100,000. Your C corporation will owe Delaware corporate income tax of $8,700, which is 8.7% of $100,000). Also, considering that you choose to utilize the authorized shares method to calculate your franchise tax, your corporation will also owe franchise tax of $150. Note that $150 tax is for corporations with 5,000 to 10,000 authorized shares.
For Wyoming C Corporation, check the following tax implications:
- C Corporations in Wyoming file on IRS Form 1120 and report earnings and taxable profit.
- A C corporation may be subject to estimated tax payments (quarterly).
- A C Corporation will be liable for employment taxes.
- C Corporation is required to file for a “Federal Tax Identification Number” using Form SS-4.
- It is important to read Publication 510, “Excise Taxes”, to determine any excise tax liabilities.
You can consider C Corporation if looking for a traditional corporation and want your personal assets to be protected from the business liabilities.
S Corporation is a separate legal entity created by a state filing. The S corporation has filed an exceptional election with the IRS to be treated like a partnership or LLC for the tax purposes. Therefore, S corporations are not subject to corporate income tax. Rather, their income is subject to “pass-through” taxation.” In pass-through taxation, the income, profit or loss of the business is passed through the company to the owners or shareholders. It means that S corporation income is not subject to double taxation like C corporation income.
In Nevada, an S Corporation with more than one shareholder is required to file an informational K-1 tax return. The S corporation does not pay any income taxes itself. Rather, the individual shareholders must add their share of the corporation’s profits on their personal tax returns, paying tax at their individual tax rate. Unlike C Corporation shareholders, S Corp shareholders are permitted to offset other income by incorporating their share of the corporation’s losses on their personal tax returns provided, but, they cannot subtract the corporate losses in excess of their “basis” in their stock – that being the amount of their investment in the company, with a few modifications.
Note that no more than 25% of an S Corporation’s gross corporate income may be derived from passive income.
An S corporation in Delaware is initially created by forming a traditional corporation, and then filing a special form with the IRS to elect “S” status. An S corporation is not subject to separate federal income tax. Instead, taxable income from an S corporation is passed through to the particular shareholders, and each shareholder is subject to federal tax on his or her share of that income. Therefore, S corporations are “pass-through” entities. Delaware acknowledges the federal S election and does not require Delaware S corporations to pay income tax. However, it does expect these businesses to pay the state’s franchise tax. Moreover, an individual S corporation shareholder will owe tax to the state on his or her share of the company’s income.
For instance: If your Delaware S corporation has a taxable net income of $100,000, 10,000 authorized shares, assumed no-par capital of $100,000, and assumed par value capital of $100,000. Your S corporation will be subject to Delaware franchise tax; depending on if you choose to utilize the authorized shares method to calculate that tax. Your Delaware S corporation will also owe franchise tax of $150 (Note that $150 tax is for corporations with 5,000 to 10,000 authorized shares). Hence, the remaining income will be allocated to you and your shareholders, and you will each have to pay tax on your own portions on your respective state tax returns.
Under the Subchapter S election for taxation as a partnership, the S corporation pays no income taxes and corporation income or loss is passed through direct to the stockholders.
To avoid the double taxation in C Corporation, you can choose S Corporation.
Nevada ranks 3rd in the nation’s State Business Tax Climate Index. The study compares the states in the five areas of taxation that affect business: individual income taxes; corporate taxes; sales taxes; unemployment insurance taxes; and taxes on property, including residential and commercial property.
Hence, there are vital tax consequences that flow from state to state in each of these choices. So, before choosing your business entity don’t forget to weigh the tax issues against the non-tax issues. This way it will be helpful for you to operate and grow the business and will be easier for you to pass to your heirs.