Entity Selection: More than Just Tax Rates

Businesses can choose their legal structure, which impacts their taxes. In light of current tax rules as well as the proposed Tax Reform Act of 2014 and the President's budget proposals, which entity is best for you?

There's probably no set answer, but there are tax factors you should consider.

Entity selection's impact on employment taxes
Employees pay FICA tax on salary and other taxable compensation, and their corporations match the tax. Sole proprietors, partners, and members in limited liability companies (LLCs) -- all of whom are self-employed -- pay a self-employment tax on net earnings from self-employment. The amount of the tax is essentially equal to the employer and employee share of income. The term net earnings from self-employment is a fancy term for a self-employed individual's share of the business's profits.

• Wages. If you don't pay your workers on time and in full, you risk losing them. What's more, failing to pay wages is a violation of the federal Fair Labor Standards Act. Strict rules govern when and to what extent you can cut back hours or reduce wages in a cash crunch. States may also impose civil penalties for nonpayment of wages.
• Employment and sales taxes. The funds you withhold from your employees' paychecks to cover their withholding and their share of FICA taxes are called trust fund taxes because you hold them in trust for your staff. If you fail to pay them to the government, you are 100% personally liable for them, even if your business is a corporation or limited liability company. The same is true for state and local sales taxes you collect from customers and hold for the government; you must remit them or face steep penalties (and possibly business closure).
• Other taxes. If you fail to pay federal and state income taxes, you'll start to accrue penalties and interest. While interest rates are low, the penalties and interest can mount up quickly, raising your tax bill in no time.  

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