Selecting a business structure affects many aspects of your company, including taxes. Each business structure comes with its own tax rules and responsibilities.
Understanding these differences can help you make an informed decision for your business.
Sole proprietorships
A sole proprietorship offers the simplest business structure but has significant tax implications. In Kentucky, sole proprietorship income counts as personal income. The owner reports business income and expenses on their individual tax return. This structure avoids double taxation but also holds the owner personally liable for all business debts and taxes.
Partnerships
Partnerships follow similar tax rules as sole proprietorships. The partnership does not pay income taxes directly. Instead, individual partners report their share of profits and losses on personal tax returns. Each partner pays taxes on their income share, even if the partnership does not distribute profits.
Corporations
Corporations in Kentucky operate under different tax rules. A traditional C corporation pays corporate income tax at both federal and state levels. Shareholders then pay taxes on dividends, resulting in double taxation. However, corporations can access certain tax deductions and credits. S corporations avoid double taxation by passing income and losses directly to shareholders, who report them on personal tax returns.
Limited liability companies (LLCs)
LLCs provide flexibility in taxation. By default, single-member LLCs follow sole proprietorship tax rules, while multi-member LLCs follow partnership rules. LLCs can also elect to be taxed as corporations if that structure offers better financial advantages. In Kentucky, LLC members pay self-employment taxes on their income share.
Choosing the right structure
Choosing the best business structure requires understanding how taxes will impact your finances. Each option has unique benefits and challenges. By evaluating tax implications and long-term goals, business owners can decide on a structure that supports financial success.