How to Slash Your Tax Bill by Changing Your Business Structure

It’s that time of year when news articles start to pop up on your news feed about taxes. While I’m sure you’ve seen your share of advice about how to file your taxes, I think about things a little differently.

Since 1997, my husband and I have helped over 1 million entrepreneurs set up and operate their businesses, and there is one common issue that I regularly see among entrepreneurs. Once a business entity is created, it’s often left untouched. Not that I blame them — an entrepreneur’s plate is always full with sales, training and finances. There are a million decisions to make, fires to put out and customers to satisfy. Why change something unless you absolutely have to?

But tax season, I find, is a good time to look at whether your business structure is still serving you. After all, if you’ve been running your business for a year or two or several, then both you and your business have changed and evolved.

Here are some things to consider when reviewing your business entity.

• Do your business goals still align with your entity?
• Is your company still growing in a way that makes sense for your business entity?
• What do you foresee the next 3-5 years looking like?

Answering these three simple questions will help you decide whether your business structure should stay the same or change.

Flexibility is the key to success

Most entrepreneurs recognize that change is happening at an unprecedented rate. The uncomfortable truth is that stability is no longer a guarantee of success, even for companies that appear established and resilient. I’ve seen seemingly unshakeable companies fall into a slump while others seized opportunities that didn’t exist just a few years earlier.

You need a business entity that allows you to accelerate or put the brakes on before it’s too late. You may need to hire quickly, change direction, launch new offers, restructure entire divisions or enter into new markets just to stay competitive. The right business entity gives you structure and flexibility so you can make quick decisions while still providing you and your stakeholders with the confidence, clarity and protection you need. So what is the right business entity for your company?

The most common structures

I’ll start with a sole proprietorship, which, in some ways, offers the most flexibility. You aren’t beholden to shareholders, employees or anybody else. The downside is, of course, that you cannot grow in a tax-efficient way. At a minimum, the tax rate of a sole proprietor is 15.3%, which includes a 12.4% Social Security tax and a 2.9% Medicare tax. However, as your earnings go up, so do your taxes, which means it’s not necessarily the best structure for high-growth companies.

Next, we have the Limited Liability Company (LLC), which is one of the most popular structures for many small business owners because it offers protection, simplicity and is still flexible enough for growth. Your business entity can have a single owner or multiple so you can easily bring on investors or experienced partners. And structured correctly, you can pay people in a way that doesn’t necessarily match the ownership percentage. Another big advantage is that an LLC has some flexibility in how it’s taxed, but profits are generally subject to the same taxes as a sole proprietorship.

Next, we have a C-Corporation, a common business entity designed for scalability and robustness. It’s uniquely positioned for large-scale growth, outside investment and various forms of ownership, perfect for high-growth companies. Owners hold shares, and the company is governed by a board of directors, providing a clear governance structure.

While this type of structure offers a high level of flexibility, it can also introduce added complexity that may not be ideal for smaller business owners. And although it may seem like the most adaptable option at first, having many stakeholders often slows down decision-making, which can reduce agility and make it harder to respond quickly to changing conditions — not something many entrepreneurs consider when thinking about their business structure.

There is also the S-Corporation, which is essentially a subset of an LLC or a C-Corp. While LLCs and C-Corps are legal business structures, an S Corporation is a tax classification that the IRS allows certain businesses to “elect.” This changes how business entities are taxed and how they report, while still keeping the same underlying legal entity. A S-Corp entity usually doesn’t pay federal income tax itself. Instead, their profits, losses and deductions are passed through to the owners or shareholders, who then have to report them on their personal tax returns.

An S-Corp can help business owners avoid double taxation (unlike a C-Corp, where profits may be taxed at both the business and personal levels), while also providing personal liability protection for its shareholders. But it comes, of course, with its own set of restrictions, including a limited number and type of shareholders, which can be a barrier to raising significant capital. In addition, electing S Corp status can also create more complicated tax reporting than an LLC tax setup, and some states may require extra filings or may not fully recognize S-Corp tax treatment for state income tax purposes, so check with your accountant before deciding if an S-Corp is right for your business entity.

The flexible framework

So how do you decide which entity is right for your business? At CorpNet, I’ve discovered that you need to answer three essential future-facing questions.

If revenue doubled (or fell by 50%), could I dispense payment and salaries without penalties?

You should be ready for any scenario. If your revenue suddenly jumped, how easy would it be to onboard new employees (or contractors) and get them paid? How easy would it be for you to take money out of the company without a tax penalty? Alternatively, if revenue dropped and you had to tighten compensation, preserve cash and perhaps even lay some people off, could you do it without panicking?

If I needed to change ownership in the next 12 months, could I do it easily?

Most entrepreneurs don’t plan for this type of problem, but it’s more common than you might think. Perhaps someone in your family unexpectedly gets sick. You might then need to sell the company. Or perhaps you triple your revenue and want to bring on a partner with expertise in managing a larger company. A flexible entity makes ownership clear, protects everyone (including the employees) involved and prevents the company from becoming fragile if the unexpected occurs. If you can’t adjust ownership without confusion, tax surprises or damaging relationships, then your business isn’t as stable as you might think.

If you require heavy investment, do you have the structure to support it?

The real test of flexibility is whether your current structure can support investment. This could be a bank loan, a loan from a family member or a VC investor. Unless you are happy as a sole proprietor with no plans to scale, it’s always a good idea to set yourself up for investment, whether it is in your immediate plans or not. If you suddenly see an opportunity in the marketplace, it would be a shame not to be able to jump on it because of a lack of capital.

Final thoughts

When you are in tax season, I want you to look beyond just the numbers because, while they do provide some clarity into your business, they don’t offer the whole picture. I want you to examine why you are paying the amount of taxes you are and if you are truly setting yourself up for success this year. Taxes are stressful, and it can be tough to do big-picture thinking at the same time, but now really is the time to ask these hard questions. And I get it. It can be overwhelming to think about whether your business structure still serves you, but ultimately, by examining it closely and checking whether your entity aligns with your goals and trajectory, you will ensure your business runs smoothly for the foreseeable future.

It’s that time of year when news articles start to pop up on your news feed about taxes. While I’m sure you’ve seen your share of advice about how to file your taxes, I think about things a little differently.

Since 1997, my husband and I have helped over 1 million entrepreneurs set up and operate their businesses, and there is one common issue that I regularly see among entrepreneurs. Once a business entity is created, it’s often left untouched. Not that I blame them — an entrepreneur’s plate is always full with sales, training and finances. There are a million decisions to make, fires to put out and customers to satisfy. Why change something unless you absolutely have to?

But tax season, I find, is a good time to look at whether your business structure is still serving you. After all, if you’ve been running your business for a year or two or several, then both you and your business have changed and evolved.