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Think tax and liability consequences in a business startup

If you are thinking of starting a new business, what form will it take? There are several choices ranging from a sole proprietorship to an S corporation, and much will depend on the kind of product or service you plan to offer.

When considering the kind of entity that would be best for your business, do not forget to weigh the tax ramifications as well as the level of liability exposure you would have. Here are three common examples of business formation:

1. The simple choice

The simplest business format is the sole proprietorship because you simply start selling your service or product. You do not need a tax ID number, a DBA registration or even a business bank account. You cover your income and expenses on a 1040 Form, Schedule C. However, you must pay the hefty self-employment tax on your ordinary net income, and, as the owner of the business, you bear personal responsibility for any liabilities.

2. A favorite option for partnerships

Many partnerships go with the limited liability company because it protects each partner from the actions of the others and makes for efficient tax planning. Although it affords personal protection from lawsuits, this format does not save on taxes; for example, the self-employment or SE tax is still applicable on ordinary net income. Some businesses use LLCs to hold rental properties; they protect property owners and managers from business and rental operations.

3. Popular with small businesses

The S corporation is often the next step for a sole proprietorship or LLC. Although this format restricts a business to no more than 100 shareholders, it is not subject to corporate tax, something the shareholders are happy to avoid. Also, the S corporation allows the business owner to pay SE tax only on the company’s payroll and not on flow-through income, which represents significant savings. In addition, neither shareholders nor officers can be liable for the debts and liabilities of the corporation.

Making the right decision

There are also professional corporations, limited liability partnerships and other structures to consider. When you are ready to go forward with your startup, an experienced attorney can help you make the right choice given the various aspects, including prudent planning for managing taxes and liabilities.

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