Choosing the Right Business Entity
Posted by Alexander Intihar on August 11, 2025
One of the most important decisions you’ll make when starting or restructuring a business is choosing the right entity type. This choice affects not only your tax obligations but also your administrative workload and compliance requirements. While legal liability is also a key consideration, this article focuses specifically on tax implications. For legal advice, consult a qualified attorney.
Whether you're launching a new venture or reassessing your current structure, understanding how each entity is taxed can help you make strategic, informed decisions. Let’s explore five common business entities and how they impact your taxes.
1. Sole Proprietorship: Simplicity with Full Responsibility
A sole proprietorship is the most straightforward business structure. It’s owned and operated by one person and requires minimal setup.
- Taxation: Income and losses are reported on the owner’s personal tax return (Schedule C of Form 1040). The income is subject to a 15.3% federal self-employment tax. The owner may also qualify for the Qualified Business Income (QBI) deduction, which can reduce the effective tax rate.
- Compliance: Minimal paperwork is required beyond licenses and business name registration. However, the owner is personally liable for all business debts and obligations.
2. S Corporation: Pass-Through Taxation with Payroll Strategy
An S corporation (S corp) offers pass-through taxation benefits but comes with stricter rules and formalities.
- Taxation: S corps don’t pay federal income tax at the entity level. Profits and losses pass through to shareholders via Schedule K-1 and are reported on individual returns. Shareholders who are employees receive a salary (subject to payroll tax), while additional profit distributions are not subject to self-employment tax. QBI deductions may apply.
- Compliance: Must meet specific criteria (e.g., 100 or fewer shareholders, U.S. citizens/residents, one class of stock). Requires filing Form 2553, issuing annual K-1s, and maintaining corporate formalities. An informational return (Form 1120-S) is also required.
3. Partnership: Collaborative Ownership with Flexibility
Partnerships involve two or more individuals jointly operating a business. Types include general partnerships, limited partnerships, and LLPs.
- Taxation: Partnerships are pass-through entities. The business files Form 1065, and income/loss is distributed to partners via Schedule K-1. General partners pay self-employment tax; limited partners typically do not. QBI deductions are available.
- Compliance: Requires a detailed partnership agreement and coordinated recordkeeping. Offers flexibility for growing businesses but involves more complexity than sole proprietorships.
4. Limited Liability Company (LLC): Customizable and Protective
An LLC combines features of corporations and partnerships, offering liability protection and operational flexibility.
- Taxation: By default, single-member LLCs are taxed like sole proprietorships; multi-member LLCs like partnerships. LLCs can elect to be taxed as a C corp or S corp by filing Form 8832 or 2553. Non-C corp LLCs may qualify for QBI deductions.
- Compliance: Requires articles of organization and often an operating agreement. Compliance varies by state and may include annual filings.
5. C Corporation: Double Taxation with Growth Potential
A C corporation is a separate legal entity that offers strong liability protection and scalability through stock issuance.
- Taxation: Subject to double taxation — the corporation pays taxes on earnings (currently 21% federal rate), and shareholders pay taxes on dividends. However, C corps can offer deductible benefits and retain earnings. Not eligible for QBI deductions.
- Compliance: Requires extensive formalities including bylaws, annual meetings, board minutes, and federal/state reporting. Ideal for businesses seeking venture capital or planning an IPO.
Hiring Employees: A Tax and Compliance Milestone
Regardless of your entity type, hiring employees introduces new responsibilities:
- Obtain an Employer Identification Number (EIN)
- Withhold federal and state payroll taxes
- Comply with employment laws and benefit regulations
- Make timely tax deposits
What’s Right for You?
There’s no one-size-fits-all answer. The best entity depends on your business goals, ownership structure, and financial strategy. For example, an LLC electing S corp status may help reduce self-employment taxes if structured properly. If you need help, we can work with your attorney to ensure your business structure supports both your tax strategy and long-term goals.
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Alex joined the Firm as a member of the tax team in early 2018. As a tax manager, he works with individuals and privately owned commercial businesses to provide tax compliance and planning services. Alex’s primary focus areas are professional services and real estate.