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Business formation can impacts taxes

Last year's federal tax law made business formation even more challenging. In addition to regular business law considerations, small employers must now consider the tax consequences of the business they elect to form even more than they did before.

The right business entity structure can possibly lower its tax bill by 10 to 40 percent. Small business owners can take advantage of a potential 20 percent pass-through deduction that starts in 2018 for the self-employed, sole proprietors, S-corporations, and partnerships.

There are income limitations for this pass-through for some professionals. Doctors, lawyers, financial planners, and other service industry professionals must have an income that is below $207,500 for single filers and $415,000 for married filers in order to qualify. These service professionals usually set up an S-corporation for tax reasons and to protect assets when the professional is self-employed. The S-Corporation is a pass-through entity that does not pay taxes on its corporate income. Profits go to the owner who then pays taxes on their personal returns.

A C-corporation is a company, like a start-up or big corporation that has gone public or plans to go public. The corporate entity is taxed separately from its shareholders. While S-corporations are limited to 100 shareholders, C-corporations have no restrictions on ownership.

The biggest drawback of this business structure is double taxation because the corporation is taxed on profits, then shareholders are taxed on their dividends. But the new lower top corporate rate is 21 percent, which may encourage startups to consider taxation as a C-corp. Also, shareholders of startups may be able to sell their stock after five years without tax on the first $5 million of gain.

Finally, a limited liability company is a legal designation and not a tax designation. Owners can file as a partnership, S-corporation, or sole proprietorship. Owners report profits and losses on their personal tax returns.

Having a business set up as a corporation or LLC helps protect business owners' personal assets in the event of bankruptcy or lawsuit. There must be an operating agreement or bylaws before this business type can be created, the entity should have books and records, and it must track its minutes to keep asset protection and tax-preferred status.

An attorney can help for these entities and provide advice on their operations. A business law attorney may also be vital in drafting necessary documents.

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