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The Tax Differences Between Partnerships, Corporations and Limited Liability Corporations (LLCs)

The Tax Differences Between Partnerships, Corporations and Limited Liability Corporations (LLCs)

You need to select the right legal form for your business. Each form has different benefits and drawbacks, so it is critical that you carefully consider your options and the specific needs of your business. Your chosen form will have significant tax ramifications for your company. If you are in the process of starting a small business or think you might be in the future, an experienced Pennsylvania small business attorney can help.

Partnerships

A partnership is always a pass through entity. This means that the partnership itself is not actually taxed, but the partners will be taxed individually on their share of the partnership income. Essentially, for taxation purposes, the income passes right through the partnership and goes to the individual. There is much less paperwork involved with a partnership, but there are also fewer business deductions available. A partnership makes sense for some small businesses. But, it is also important to remember that a partnership does not shield its owners from legal liability.

Corporations vs. LLCs

Unlike partnerships, both corporations and LLCs will shield your personal assets from liability in the event that your business is sued. This ability to minimize exposure makes both options popular choices. As far as taxes go, there are a few important differences between the two options:

  • Pass through: An LLC can be set up as a pass-through entity, similar to a partnership, whereas a corporation is a totally separate tax entity. For some businesses, the pass-through option is desirable. An LLC provides for a lot of flexibility. Leaving money in the business: The advantage of not having a pass-through entity is that you can easily leave money in your business. Setting up a corporation gives you the option to avoid taking distributions. For some businesses that is an important benefit.
  • Employment taxes: Social Security and Medicare taxes are levied on employment income. If you work for your own small business, this is an important point to consider when choosing a company form. If your business is set up as a pass-through entity, all of your pass through income could be subject to self-employment taxes.
  • Deductions: Different business forms can allow for different deductions. For example, if you are working at your own small business, then you might be able to deduct certain expenses from your personal income tax liability by setting up your business as an LLC.

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