Consider Tax Implications When Changing Your Business Structure


Change happens. Perhaps your one-person business has blossomed into a 15-person agency. With all of the changes your business has undergone, it might be time to reassess its structure. Before you do, however, remember this: the business structure you choose will affect many aspects of your business, from the amount of paperwork you have to file to the level of personal liability for which you are responsible. Note, too, that the choice you make could have a significant impact on the taxes you will pay during the year in which you switch. It’s important to weigh that against the long-term benefits of changing your business structure.

Here are the most common types of small business structures recognized by local, state and federal government agencies:

Sole proprietorship
This is the most common business structure and, according to Thrasher, the easiest to establish. Sole proprietorships are inexpensive to form, and owners benefit from having complete control over business decisions. “One of the biggest disadvantages of being a sole proprietor is that the financial burden is all yours,” according to Ellen Thrasher, associate administrator for the Office of Entrepreneurship Education at the U.S. Small Business Administration. “You reap all of the rewards, but you also take all of the risks.”

Sole proprietors are not required to file separate tax returns for their businesses. Instead, the IRS requires owners of sole proprietorships to claim their business income and expenses on an individual tax form.

Like sole proprietorships, partnerships are simple and inexpensive to form. One of the biggest advantages of a partnership, according to Thrasher, is sharing the start-up costs and taking equal responsibility for the liabilities, including business debt. The liabilities are also a disadvantage of a partnership because there is no protection for the personal assets of the partners. In a partnership, partners are required to claim the profits, losses and business expenses on their personal tax returns; partnerships do not require business tax returns.

Limited Liability Company (LLC)
An LLC is a hybrid business structure that incorporates elements of corporations and sole proprietorships. “LLCs are popular among small business owners because they offer the liability protection of a corporation with the tax advantages of a sole proprietorship,” Thrasher said. Each state has its own regulations governing LLCs. At the federal level, the IRS does not tax an LLC as a separate business. Instead, members are required to report business profits and losses on their personal income tax returns. The investment of time and money that it takes to establish an LLC is one of its main disadvantages, according to Thrasher.

Unlike other business structures, which are owned by individuals, the IRS defines a corporation as an independent legal entity that is owned by shareholders. In addition to allowing the business to raise capital through the sale of stocks, corporations provide the advantage of sheltering shareholders from liabilities, including business debts. Corporations are required to establish bylaws and articles of incorporation and file corporate tax returns. “Setting up and maintaining a separate entity requires a lot of work, which is one of the main disadvantages of this structure,” Thrasher said. Each state has its own laws for forming a corporation. If that’s not enough to confuse you, there is one form of corporation, best known by its nickname, “S Corporation,” that is very similar to an LLC in the way profits and losses are reflected in the shareholders’ personal tax returns.

As you can see, changing the legal structure of a company is very complicated and should only occur after in-depth consideration by the owners of a small business and their legal, accounting and tax advisers. The process can be time-consuming and costly. And, if done poorly, it can create problems down the road that can jeopardize relationships with friends and family members, and even threaten the future of the company.

All content provided herein is for educational purposes only. It is provided “as is” and neither the author, publisher nor Triad Digital Media, LLC d/b/a Triad Retail Media warrant the accuracy of the information provided, nor do they assume any responsibility for errors, omissions or contrary interpretation of the subject matter herein.

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