As a business owner, one of the critical decisions you need to make is the type of business structure you select. This decision can significantly impact your tax bill, and understanding your options, as well as the implications of the Qualified Business Income (QBI) deduction, is crucial. In this article, we will discuss how different business structures can affect your tax bill and provide insights into choosing the most suitable entity for your organization.
Different Tax Treatment for Different Business Structures
A case study demonstrates that a $500,000 income can be taxed differently based on the business structure and the QBI deduction:
- Corporation (100% distribution): $152,670 (30.53%)
- SSTB (no QBI deduction): $126,379 (25.28%)
- Corporation (25% distribution): $108,233 (21.65%)
- QTB (20% QBI deduction): $91,379 (18.28%)
This information shows how crucial organizational structuring can be due to its significant tax consequences. The key takeaway is that you have choices as a business owner.
Understanding SSTB and QTB
An SSTB is a Specified Service Trade or Business, which is a classification under the Tax Cuts and Jobs Act (TCJA) of 2017. SSTBs include businesses in various fields, and they have limitations on the QBI deduction. However, for SSTBs, the QBI deduction is subject to income phase-out limits based on the taxpayer’s income.
A Qualified Trade or Business (QTB) is any trade or business that is not an SSTB and is eligible for the QBI deduction without income limitations. By being classified as a QTB, a business owner can benefit from the full 20% QBI deduction, resulting in significant tax savings.
Options for Business Structures
For a for-profit operating entity, you have the following options:
- Sole Proprietor
- Partnership
- Corporation
- S Corporation
If you have already set up your entity, “late election reliefs” are often available to make changes. Moreover, businesses can use multi-entity approaches when the tax advantages make sense.
S Corporations and Multi-Entity Structures
For closely held businesses with more than one owner, multi-entity structures can be beneficial. For instance, if a business owner wants to set up an S corporation but requires unequal distributions, they could establish an S corporation holding company for each owner within an LLC structure. This approach offers flexibility in determining reasonable salaries and allows each owner to implement their preferred tax planning strategies.
However, it’s essential to understand that the primary tax benefit of S corporations comes from avoiding self-employment taxes, not federal taxes, most of the time. This fact is often misunderstood and overlooked.
Conclusion
Choosing the right business structure is vital for optimizing your tax savings. By understanding your options, the implications of SSTB and QTB classifications, and working with a professional to evaluate your specific situation, you can make the best decision for your business and save money on taxes in the long run. See our tax service offerings here. Utilize the resources available and make informed decisions to ensure that your business is structured in the most tax-efficient way possible.
Joe Gallegos, CPA/CVA
Partner-in-Charge · JAG CPA & Co.
Author of The Ultimate Guide to Choosing a CPA
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