Test Your Structural Integrity Why your business structure could be eating away at your company's bottom line
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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."
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.