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Starting a Business

Test Your Structural Integrity

Why your business structure could be eating away at your company's bottom line
Test Your Structural Integrity
Magazine Contributor
4 min read

This story appears in the August 2009 issue of Entrepreneur. Subscribe »

The structure of your business--whether it's a sole proprietorship, an LLC, or an S or C corporation--can directly affect your business's financial health. You've probably already weighed legal and other matters when settling on a business structure, but tax considerations can be just as essential--and can dip into your bottom line if you're not careful. Just ask Beth Shaw, president and founder of YogaFit Training Systems Worldwide Inc. The midsize company, with five million in sales, started out as an S corp, but "I wanted more levels of protection, so we switched to a C corp," Shaw says. Problem was, when tax season came around, that so-called protection translated into a 25 percent jump in taxes. "Now we're planning to go back to being an S corp."

What's that business structure costing you?

If your business is a sole proprietorship, it's probably not costing you too much. If you own a partnership or an S corp, on the other hand, it may be time to rethink your business structure. -J.L.

Average tax rate for small businesses: 19.8%

Sole proprietorships: 13.3%

Partnerships: 23.6%

S corps: 26.9%

C corps: 17.5%*

*not directly comparable, as salaries and dividends are also taxed

That kind of realization is nothing new to tax expert Julian Block, a former IRS special agent, who says the tax burden on a C corp can be big. "A C corp is a taxable entity separate from its shareholders. The profits are taxed to the corporation. If the C corp is paying a salary to shareholders, those salaries are taxable to the shareholders--so are dividends. So there's a double taxation." By contrast, at an S corp or LLC, profits are taxed only once, on the shareholder's 1040s. If losses occur, shareholders can write those off too, Block says.

Richard J. Foster, president of Foster Construction Management LLC, has owned and operated more than five businesses, each with its own corporate structure. He says that while there isn't a huge difference in costs between corporate structures when starting up, "there's far less paper-pushing with an LLC," which translates into savings over time. The drawback to an LLC is that you can't take it public, and venture capitalists may prefer a different structure. But, as Foster points out, you can always switch structures to meet your company's changing demands.

If you're considering changing your business structure to improve your bottom line, Block suggests meeting with a qualified tax professional several months before the end of the tax year (December 31 for most small businesses) because mid-tax-year changes are more costly and time-consuming.

How to Become Efficiency Fit
Operational efficiency audits can put money in your wallet--and save you and your employees time and effort. By looking at how you do almost anything in your business, from ordering and storing inventory to handling accounts payable and receivable, you can not only troubleshoot existing problems, but also save money. A consultant can help you determine if your business is operating at peak efficiency, but if you decide to go it alone, there are a few questions you'll want to consider. Ed Engoron, president and CEO of Perspectives, The Consulting Group Inc., offers the following queries.

  • Are cash-flow issues the result of too few sales or wasteful and inefficient spending? The best way to improve cash flow is to improve sales. "If you have bad customer service or a product problem, no way are you going to be able to improve your cash flow for the long term," Engoron says. How you tackle the problem depends on your answer to this question.
  • Are your employees deployed at appropriate times? For instance: "If we're looking at a theme park in the morning, when most visitors are going to show up, do we have enough ticket-takers?" asks Engron. "If our restaurants are fully staffed at 8 a.m., that's probably a mistake."
  • Are employees well-trained? Engoron says, "It probably costs less to train people well than to live through the expense of chased-away customers."
  • Are employees in the right jobs? It's a mistake to have an untrained new hire as the face of your company.
  • Are your quality-control efforts working? Great marketing and excellent customer service can't compensate for a bad product. --J.L.

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