Be Wise About Your Entity Type
Choosing your business entity type is one of the most important decisions you’ll make as a business owner. Do you want to establish a C corporation and take advantage of qualified small business stock and tax-free fringe benefits? Do you prefer to set up an S corporation so you can pass income and losses through to shareholders while avoiding self-employment taxes? Do you want the flexibility that comes with an LLC, which can choose to be taxed as any of the above?
Don’t make the mistake of defaulting to the “most popular” entity type or what you’re already familiar with. Entity type is a strategic tax decision and can be the difference between a hefty tax bill and massive savings.
Oops, We Formed a Partnership
What happens if you launch a business without doing your entity-type homework? If you don’t make an official election, by default the IRS will tax your business based on the number of owners. If your business has two or more owners, you will automatically be taxed as a partnership. This can come as a surprise to new entrepreneurs. Fortunately, partnerships do come with a number of tax benefits. Familiarizing yourself with these advantages is the first step to determining if this entity type is right for you.
Perks of Being a Partnership
Partnerships offer special tax advantages that do not exist in any other entity type:
Contributions and Distributions. In a partnership, these are generally tax-free. This is a notable distinction from corporations. You can contribute property into a partnership without triggering tax, and you can often take distributions out without triggering tax. This can be especially helpful if there is a mortgage attached to that property. Remember that generally tax-free doesn’t mean always tax-free. Under the anti-abuse rules, not every business will qualify, but if you do meet the requirements, a partnership can give you the adaptability to move value in and out of the business in a very tax-efficient way.
Special Allocations. This is the heavy hitter when it comes to partnership benefits. Special allocations mean that profits, losses, and deductions can be distributed however benefits the partners most. The distributions do not have to reflect the actual ownership percentages. So even if a partnership is owned 50/50, you can split the profits and losses 25% and 75% or even 0% and 100%. There are some limitations in place to ensure partnerships are not simply trying to evade taxes, but as long as you pass the IRS’ tests, you can leverage this customization to lower taxes for all the partners in your business.
How do you figure out how to allocate losses and income strategically? That’s a question to discuss with a Certified Tax Planner.
Let’s Make a Deal
Partnerships make for one of the most flexible entity types. These multi-owner, pass-through entities allow you to determine how decisions are made amongst the partners and how finances are shared. In other words, we get to design the deal—and we do so through the partnership agreement. This is key when it comes to maximizing the tax advantages of a partnership. You want to make sure that your written and signed agreement reflects your overall tax strategy. Enlist the help of tax and legal experts to make your partnership arrangements work for you.
Connect with an Expert
The American Institute of Certified Tax Planners trains tax planners to ask the tough questions that are needed to create the best tax plan for you and your business. Whether this means maximizing your entity type’s tax benefits or restructuring the business entirely, our experts will walk with you every step of the way. Tax season doesn’t have to feel like a roll of the dice when you have a strategy in place to secure real tax savings. Get started today by reaching out to a Certified Tax Planner.
