As a small business owner, one of the most important decisions you have to make is choosing the right legal entity for your business. This choice can have a major impact on your liability protection and tax implications, both for your business and for yourself as the owner. It’s important to carefully consider both the legal and tax aspects of this decision, as many businesses overlook one or both of these important factors.
With that, Let’s examine the main entity structure for business owners and its impact on liability and taxes.
Limited Liability Company (LLC)
The limited liability company (LLC) is the most popular choice for small business owners. And for good reason – it includes built-in liability protection (it’s in the name after all) and it’s flexible from a tax perspective. This takes more setup and maintenance than the sole proprietorship and partnership since this involves a separate legal entity formed with a state; however, its benefits typically outweigh the additional costs.
- Liability Protection – LLCs offer built-in liability protection, which separates the business from the personal assets of the owner. This means that in the event of a legal issue, the owner’s personal assets are generally not at risk. However, it is important to note that proper bookkeeping and separating business and personal assets through separate bank accounts and credit cards is necessary to ensure full protection.
- Tax Treatment – LLCs are considered “flow-through” entities, where all profits and losses of the business are reported on the owners’ individual tax returns. This is similar to the tax treatment for sole proprietorships and partnerships. The tax structure of an LLC can also be changed, with two of the most common options being S Corporation or C Corporation. An LLC taxed as an S Corporation is often the most advantageous for small businesses as it provides liability protection and the ability to save on payroll tax.
- Neutral for simplicity and easy set up. Good for liability protection. Great for tax planning.