Executive Summary

Every day hundreds of businesses get set up. TaxAssurances often gets asked either before a business is set up or even after it was set up what is the best way to set up the company taxwise. At the end of the 2022 tax season, I met with a soon to be retiring teacher. They also want to start a business. That’s where I come in. They needed to get my expertise on the best type of entity to set up. Now I let them know that I do not actually set up the business and also that I give strictly tax advice when it comes to setting up a new business. There are other things to consider and for that they would need to talk with a legal adviser, insurance adviser and maybe other advisers as well. That said, here is what came out of that meeting.

Background

• They currently work in NYC as a teacher and live in Westchester County, NY which is a suburb of NYC.
• They do not live in Yonkers, NY which has its own city tax on income for its residences.
• They rented their home and did not own it.
• They made over $107k in 2022.
• They did not have any other income in 2022.
• They are not married.
• They do not have any dependent children.
• They did not make any charitable donations.

Here is a brief IRS summary of the various business types they have to choose from:

Sole Proprietorship

A sole proprietor is someone who owns an unincorporated business by himself or herself. However, if you are the sole member of a domestic limited liability company (LLC), you are not a sole proprietor if you elect to treat the LLC as a corporation.

LLC

A Limited Liability Company (LLC) is a business structure allowed by state statute. Each state may use different regulations, you should check with your state if you are interested in starting a Limited Liability Company.

Owners of an LLC are called members. Most states do not restrict ownership, so members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Most states also permit “single-member” LLCs, those having only one owner.

A few types of businesses generally cannot be LLCs, such as banks and insurance companies. Check your state’s requirements and the federal tax regulations for further information. There are special rules for foreign LLCs.

Partnership

A partnership is the relationship between two or more people to do trade or business. Each person contributes money, property, labor or skill, and shares in the profits and losses of the business.

S Corp

S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income at the entity level.

To qualify for S corporation status, the corporation must meet the following requirements:

• Be a domestic corporation
• Have only allowable shareholders
  • May be individuals, certain trusts, and estates and
  • May not be partnerships, corporations or non-resident alien shareholders
• Have no more than 100 shareholders
• Have only one class of stock
• Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).

C Corp

A corporation generally takes the same deductions as a sole proprietorship to figure its taxable income. A corporation can also take special deductions. For federal income tax purposes, a C corporation is recognized as a separate taxpaying entity. A corporation conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders.

The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. This creates a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any loss of the corporation.

Results

• They received a federal tax refund over a little over $700 and had it returned to her through direct deposit.
• They owed a little over $200 to NYS for underpayment in taxes for the year primarily due to the fact that they contributed to the NYS 414H retirement plan and it is taxable at the NYS level.
• Because they are a teacher, they were able to take the $300 educator expense deduction.
• Because they rent her home and does not own it, it was more advantageous from a tax standpoint to take the standard deduction instead of the itemized deduction..

Challenges & Solutions

There is a lot to consider in starting a business. For many new founders the big concern has to do with taxes. Namely, which entity gives the best tax benefits. While that’s a critical part of the entity selection process I always let them know that it’s not the only thing to consider. Once I do that, I walk through the various tax implication of each entity with mock income scenarios. That way they can understand how income and expense factor into which entity they choose.

Solution

Based on a variety of factors after we discussed the details of this founder’s startup we determined that is was probably best to set up the business entity as an S Corporation.

Conclusion

Based on the background details and tax considerations, an S corporation was determined to be the best business entity for this new startup. As a teacher earning over $100k annually, the founder would benefit from the pass-through taxation of an S corp. This avoids the double taxation of a C corp while also providing liability protection like an LLC.

Additionally, since the founder does not plan on seeking outside investors or having more than 100 shareholders, the ownership restrictions of an S corp will not be an issue. The pass-through deductions and ability to offset personal income with business losses makes the S corp advantageous over filing taxes as a sole proprietor.

While an LLC does provide flexibility and similar pass-through tax treatment, the ability to have self-employment tax savings as an officer of an S corp makes the S corporation more beneficial in this case. By electing to be taxed as an S corp and following the applicable IRS requirements, this teacher can reduce personal tax liability and save money to put back into growing their new business. Consulting with legal and accounting advisers on the ongoing requirements will help ensure the S corp status remains intact going forward.