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Tax guide to choosing the right business structure

When you’re starting or restructuring a business, one of the first big decisions is choosing your business entity. This choice affects how you pay taxes, the amount of paperwork you’ll deal with, and the level of protection for your personal assets.

In this post, we’ll focus on the tax side of things (for legal liability questions, you’ll want to talk to an attorney).

Here’s a breakdown of the most common options:

1. Sole Proprietorship: Simple but with full responsibility

• What it is: One person owns and runs the business.

• Taxes: Income and expenses go directly on your personal tax return (Schedule C, Form 1040). You’ll also pay self-employment tax (15.3%). On the plus side, you may qualify for the Qualified Business Income (QBI) deduction, which can lower your taxable income.

• Compliance: Very little paperwork, but you’re personally on the hook for all debts and obligations.

2. S Corporation: Tax benefits with extra rules

• What it is: A special tax status (not a separate type of business) that allows profits to “pass through” to the owners.

• Taxes: Profits go to shareholders’ personal returns (via Schedule K-1). Owners who work in the business must take a reasonable salary, which is subject to payroll taxes. Extra profits can be taken as distributions that avoid self-employment tax. S corps can also qualify for the QBI deduction.

• Compliance: Requires more paperwork—like filing Form 2553, annual returns, shareholder meetings, and issuing K-1s. There are restrictions: 100 or fewer shareholders, all must be U.S. citizens/residents, and only one class of stock.

3. Partnership: Two or more owners, shared profits

• What it is: A business run by two or more people. Can be a general partnership, limited partnership, or LLP.

• Taxes: The partnership itself doesn’t pay taxes. Instead, it files Form 1065, and each partner gets a K-1 showing their share of profits or losses. General partners pay self-employment tax; limited partners usually don’t. Partnerships also qualify for the QBI deduction.

• Compliance: Requires a good partnership agreement, clear profit-sharing rules, and coordinated recordkeeping.

4. Limited Liability Company (LLC): Flexible and protective

• What it is: A popular choice because it blends liability protection with flexibility. Owners are called “members.”

• Taxes: By default, a single-member LLC is taxed like a sole proprietorship, and a multi-member LLC like a partnership. But LLCs can choose to be taxed as an S corp or even a C corp. That flexibility lets you fine-tune your tax strategy. Most LLCs qualify for the QBI deduction.

• Compliance: More paperwork than a sole proprietorship but generally easier than a corporation. States often require articles of organization and sometimes an operating agreement.

5. C Corporation: Complex but built for growth

• What it is: A separate legal entity that can raise money by issuing stock. Offers strong liability protection.

• Taxes: Subject to “double taxation”—the corporation pays taxes (21% federal rate), and shareholders pay taxes again on dividends. But C corps can deduct certain benefits (like health insurance or retirement plans) and can keep profits in the business. No QBI deduction.

• Compliance: Requires the most upkeep—bylaws, board meetings, annual filings, and detailed recordkeeping. This structure is usually best for businesses planning to seek investors or go public.

If you hire employees

No matter which entity you choose, once you have employees you’ll need an EIN (Employer Identification Number), and you’ll be responsible for withholding payroll taxes, handling benefits, and following employment laws.

So, which one is best?

There’s no one-size-fits-all answer. The right choice depends on your goals, how many owners you have, and how you want your taxes handled. For example, some LLCs elect S corp status to save on self-employment taxes.

If you’re not sure, talk to your local Padgett advisor. We can walk through your options and, if needed, coordinate with your attorney to make sure your structure supports both your tax strategy and your long-term business goals.

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