Choice of entity is one of the first and most important tax-planning decisions that any entrepreneur must make. Conventional wisdom holds that most entrepreneurs should organize their businesses as “pass-through” entities – primarily limited liability companies, partnerships, subchapter S corporations, or sole proprietorships. Pass-through entities are not themselves taxable. Rather, all of their income is “passed through” and taxable to their owners. By contrast, operating a business in the other main form – a corporation – subjects the business’s income to the dreaded “double tax” because the corporation itself is subject to tax, and then the shareholder is subject to tax when he receives dividends from the corporation or sells its stock at a gain.
Historically, the expense associated with the double tax has varied, depending on the prevailing tax rates, but it almost always exceeded the tax expense on pass-through income. At this unique time, however, entrepreneurs following the conventional wisdom may be missing a valuable tax-planning opportunity: two features of the American Taxpayer Relief Act of 2012 make corporations much more attractive compared to pass-through entities. (more…)