Here are some ways businesses might pay more in taxes by being in the wrong entity:
Double Taxation: Some business entities, like C Corporations, can experience double taxation. This means the corporation is taxed at the corporate level, and then shareholders are taxed again on any dividends they receive. This can result in a higher overall tax burden.
Self-Employment Taxes: If business owners choose a structure that doesn't provide a way to classify themselves as employees, they may end up paying higher self-employment taxes on all of their business income rather than just their salary.
Limited Deductions: Certain business entities have limitations on the types and amounts of deductions they can claim. Sole proprietors and single-member LLCs, for example, might miss out on certain deductions available to corporations or partnerships.
Pass-Through Loss Limitations: Some entities allow losses to offset the owner's other income, reducing their overall tax liability. If a business entity doesn't permit these losses to pass through, owners might be stuck with limited options for utilizing losses effectively.
Capital Gain Rates: Different business structures have varying impacts on how capital gains are taxed. In some cases, being in the wrong entity might lead to higher capital gains taxes when selling assets or the business itself.
Qualified Business Income Deduction: The Tax Cuts and Jobs Act introduced the Qualified Business Income (QBI) deduction for pass-through entities, allowing eligible businesses to deduct a portion of their qualified business income. Choosing the wrong entity might result in missing out on this deduction.
Franchise Taxes: Certain business entities, particularly corporations, might be subject to additional franchise taxes or fees that can increase their overall tax burden.
State Taxation: Different states have different tax regulations for various business entities. Choosing an entity that doesn't align well with a state's tax rules can lead to higher state tax payments.
Exit Strategy Taxes: When selling a business, the chosen entity can affect the taxes on the sale. For instance, being in the wrong entity might result in higher taxes upon selling the business.
Lack of Flexibility: Some entities offer more flexibility in allocating income and deductions among owners. Choosing a less flexible entity might lead to less efficient tax planning.
It's important to note that the optimal business entity choice varies depending on the specific circumstances of the business and its owners. Consulting with my team of tax professional can help you make the right choice and potentially save on taxes.