One of the most important decisions when starting a new business is choosing the legal entity type. The legal entity type you choose will affect many aspects of your business, including taxes. In Florida, the most common legal entity types for small businesses are limited liability companies (LLCs), partnerships, and corporations. In this blog post, we will discuss tax considerations in choosing a legal entity type for your start-up.
Pass-through vs. Separate Taxation
One of the main tax considerations when choosing a legal entity type is whether the entity is taxed as a pass-through entity or a separate entity. Pass-through entities, such as LLCs and partnerships, do not pay taxes on their income. Instead, the income is passed through to the owners or partners, who report it on their individual tax returns. In contrast, separate entities, such as corporations, are taxed on their income, and the owners are also taxed on any dividends they receive. This can result in double taxation, which may be a disadvantage for some businesses.
As a self-employed individual, you may be subject to self-employment taxes on your business income. However, some legal entity types, such as an S corporation, may allow you to avoid some self-employment taxes. S corporations are pass-through entities that allow owners to be treated as employees of the corporation. This means that the owners can receive a salary, which is subject to payroll taxes, and the remaining income can be distributed as dividends, which are not subject to self-employment taxes.
Qualified Business Income Deduction
The Tax Cuts and Jobs Act of 2017 introduced a new tax deduction for owners of pass-through entities called the Qualified Business Income (QBI) deduction. This deduction allows owners of pass-through entities to deduct up to 20% of their qualified business income on their individual tax returns. However, there are certain limitations and restrictions on who can claim the deduction.
The legal entity type you choose can also impact the availability of certain fringe benefits, such as health insurance, retirement plans, and other employee benefits. For example, corporations may be able to offer more robust employee benefits than pass-through entities. Additionally, the tax treatment of these benefits may differ depending on the legal entity type.
Certain legal entity types may be eligible for tax credits, which can reduce their tax liability. For example, corporations engaged in research and development may be eligible for the research and development tax credit. This credit allows corporations to reduce their tax liability by a percentage of their research and development expenses.
In addition to federal taxes, businesses must also pay state taxes. The legal entity type you choose can impact your state tax liability. For example, Florida does not have a state income tax, so the choice of legal entity type will not impact state income tax liability. However, other state taxes, such as sales and use tax, may be impacted by the legal entity type.
Change in Entity Type
It is important to note that changing the legal entity type of your business can have significant tax implications. For example, converting from a partnership to a corporation can trigger a taxable event, where the business must recognize any unrealized gains or losses. Additionally, changing the legal entity type may impact the availability of certain tax deductions or credits.
In conclusion, choosing the right legal entity type for your start-up is an important decision that will impact your tax liability. It is important to consider all of the tax implications when making this decision. Consulting with a tax professional can help ensure that you make the right decision for your business.
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When starting or operating a business, timing is critical; therefore, if you need assistance with your business venture, it is important that you retain the services of a competent Florida attorney as soon as possible.
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I am an attorney and Certified Public Accountant serving Southwest Florida.
Previously, I served in operations and finance with the world’s largest accounting firm (PricewaterhouseCoopers), airline (American Airlines), and bank (JPMorgan Chase & Co.). I have also created and advised a variety of start-up ventures.
I am a member of The Florida Bar, and I hold active CPA licensure in Florida and Texas and undergraduate and graduate degrees in accounting and taxation from Southern Methodist University in Dallas.
My practice emphasizes, but is not limited to, the law as it intersects small businesses and their owners. I also assist clients with insurance claims, estate planning, and other legal matters on an ad hoc basis. I live and work in Naples, Florida.
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