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Merlo
Merlo, Accountant
Category: Tax
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Experience:  25+ years tax consulting. Specializing in returns for US citizens living abroad
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what is the best way to structure a small business to save

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what is the best way to structure a small business to save the most on taxes? Myself and a partner are starting a small used car lot and are now structured as a general partnership, for the main purpose of using personal credit to start the business. I now have the money needed to start without using my credit for a business loan.
We still both have full time jobs other than working for our business. What is the best way to structure everything?
Submitted: 7 years ago.
Category: Tax
Expert:  Merlo replied 7 years ago.

Hello jonk,


From a tax standpoint, the S Corporation definitely affords you the best tax advantage, and here is why.

If you operate a multi member LLC, you can choose to be taxed as a partnership, and all of the partnership earnings are subject to tax in the year earned, and all of the earnings are considered to be from self-employment. The same is true if you operate a single member LLC. That means that you and any other partners pay not only federal and state income taxes on the profits, but you also pay the full share of social security and medicare taxes. Those two taxes combined is 15.3% of your net income. If you operate a single member LLC, you are basically considered to be a sole proprietor and are subject to the same very tax rules as the partnership, meaning you pay federal and state income taxes plus social security and medicare taxes on all of your earnings.

If you choose to be taxed as a C Corporation, then you have an issue with double taxation. With a C Corporation, shareholders may draw salaries from the company, and you could leave some of the profits in the corporation as retained earnings for capital or for future use. But those profits would still be taxed at corporate tax rates, and once you withdraw them from the corporation, they are then taxed to you again at the personal level as dividends.

If you choose the S Corporation status, you must pay taxes on the full amount of your earnings each year, but you can split those earnings by classifying some of them as salary and some as dividends. The IRS requires that as a shareholder of an S Corporation, you must pay yourself a reasonable salary. A reasonable salary would be the same amount of pay that someone else in your profession is being paid for the equivalent amount of hours you devote to the business. The salary that you pay yourself will be subject to federal and state income taxes as well as the social security and medicare taxes discussed earlier. But, everything you earn that is over and above your salaries, you may then withdraw those amounts as dividends, which are not subject to the social security and medicare taxes. So you automatically save 15.3% in tax on any profits that you can declare as dividends.

The S Corporation by far offers the best tax advantage and seems to be the #1 choice for people in this day setting up a new business for that very reason.

If this was helpful please press the Accept button. Positive feedback is also appreciated.

Thank you jonk and let me know if you have more questions.


Customer: replied 7 years ago.
I do not want to draw a salary for at least one year in order to build the buisness. will s corp still work
Expert:  Merlo replied 7 years ago.
Hello again jonk,

Unfortunately, whether you draw a salary or not, any profits that you have are still taxable. You cannot simply leave the profits in the business and not pay tax on them. This is true regardless of the type tax entity you choose -- partnership, S Corp or C Corp. Profits are always taxable in the year you have them.

That being the case, it is still to your advtange to elect S Scorp status. If you simply remain as a partnership, all of your profits for the year will be subject to federal and state income taxes plus the full share of SS and Medicare.

If this was helpful please press the Accept button.

Thank you jonk.

Merlo and 3 other Tax Specialists are ready to help you
Customer: replied 7 years ago.
thanks very helpful.
Expert:  Merlo replied 7 years ago.
Thank you jonk and let me know if you have more questions.



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