Starting a small business – Part II – What to set it up as and tax implications

The Right Setup

In recognition of Small Business Month, Whitaker-Myers Wealth Managers is partnering with our CPA and fellow small business owner, Kage Rush, to discuss the thought process and steps needed to open and continue to operate a successful small business or side hustle. Our first article covered things to consider when starting a small business. This article will discuss the different types of entities to consider when creating your small business, the tax implications and reporting of each entity, and what to consider when choosing an entity.

What option is best for you

After formulating a business plan to make your small business dream a reality, an owner is now tasked with deciding how to set up their business for legal and tax purposes. This decision can significantly impact your personal tax return and possibly your business partner(s) tax situation. Below is a list of the possible options for setting up your business and the federal tax reporting associated with each.

Sole Proprietorship/Single Member LLC

This is most often the setup for small businesses/side hustles or independent contractors (also known as Form 1099 employees).

  • This business entity’s activity is most commonly reported on a Form 1040 IRS Schedule C. If the activity is related to rental real estate or royalties, the income could be reported on a Form 1040 IRS Schedule E. The due date is April 15th, which is reported with your personal tax return.
  • A Sole Proprietorship is the default designation for a business with only one owner. You can file the legal forms for an LLC with an attorney, but for tax purposes, it is treated and reported the same.
  • 92.35% of Net Income (Revenue – Allowed Expenses/Deductions) is subject to Self-Employment Tax (SE Tax or FICA Tax) of 15.3% tax (12.4% is for Social Security up to earnings of $160,200 for Tax Year 2023 and 2.9% for Medicare Tax). The Net Income is also subject to standard income tax (W-2 wages). This can lead to unexpected tax bills for new owners who are used to having FICA taxes taken out automatically by their employer.
  • A sole proprietorship is easy to set up but can come with higher tax bills if not the owner is not saving back profits to pay estimated taxes.

Partnership/Multi-Member LLC

This is when two or more owners have a capital stake in the business.

  • This business entity’s activity is reported on Form 1065 US Partnership Return of Income. The due date for the tax return is March 15th.
  • A partnership does not pay taxes on Form 1065. Instead, each owner is reported their share of the income(loss) of the business on a Schedule K-1, and the tax liability is paid at each respective owner’s tax rate.
  • Owners are unable to pay themselves normal W-2 wages. Instead, payments for work done on behalf of the business can be treated as Guaranteed Payments and are subject to the SE Tax on the owner(s) personal return.
  • A partnership is required to have a signed operating agreement that dictates the breakdown of ownership in the business, how profits/(losses) are split amongst owners, what are the responsibilities of the owners, etc.
  • A partnership can be helpful for owners who want to invest in a business or idea without borrowing from a bank or third party to fund the business.
  • Potential downsides of a partnership could be the higher start-up costs required to start the business and the more complex accounting standards that are required to be followed.


This entity can have only one owner but cannot exceed 100 owners in the business. There are also further limitations on who can be an owner in an S-Corporation.

  • This business entity’s activity is reported on Form 1120-S. The due date for the tax return is March 15th.
  • A s-corporation does not pay taxes on the Form 1120-S. Instead, each owner is reported their share of the income(loss) of the business on a Schedule K-1, and the tax liability is paid at each respective owner’s tax rate.
  • Owners that are material participants in the business must pay themselves a reasonable W-2 salary. This is required because earnings reported on the Schedule K-1 from a S-Corporation are not subject to the SE Tax like a sole proprietorship is.
  • S-Corporations are only allowed to have one type of stock.
  • S-Corporations are required to have an operating agreement in place and require income(loss) and distributions to be pro-rata in accordance with the owner’s ownership percentage in the company.
  • Single Member LLCs or Partnership LLCs can elect to be taxed as an S-Corporation by filing Form 2523, Election by a Small Business Corporation, if they meet the qualifications required for an S-corporation.
  • S-Corporations can be great options for the owner(s) that want to pay themselves a salary from their business and can generate some tax savings on their personal return compared to if that entity was a Sole Proprietorship.
  • S-Corporations can also be more strenuous to set up and are subject to more complex accounting standards than a sole proprietorship.


This entity is the standard corporation you hear about in the news (Apple, Walmart, etc.)

  • This business entity’s activity is reported on Form 1120 and is due annually by April 15th.
  • A C-Corporation does pay taxes at the Federal level, unlike an S-Corporation.
  • A C-Corporation can face double taxation if income is distributed to its owners as a dividend.
  • Unlike an S-Corp, there is no limit on the number or type of owners that can invest in a C-Corporation.
  • C-Corporations can have multiple levels/types of stock.
  • C- Corporations can be great options if you bring in many different types of owners to crowdfund your business.
  • The possibility of double taxation can be a downfall for C-Corporations and can be a turn-off for owners.

Choosing the right option

The business entity you decide to form must match your expectations for the business. Each entity has its positives and negatives regarding tax advantages, ease of setup, and accounting standards required to be followed. Our Whitaker-Myers Tax Advisors, Ltd. team can help guide you on the various entities and give you the tools to decide when setting up your small business. 

I hope this article helped explain the different options available to small business owners when forming your own business. The last article (Part III) in the small business series will focus on the financial side of the day-to-day business and how understanding your business’s finances can help guide you to grow and prosper in good and bad economic times.

If you are interested in starting your own small business and have accounting questions or need accounting services, please get in touch with your financial advisor or visit our tax website to schedule an appointment.


Author: Kage Rush

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