Those planning to start a new business in Illinois have to make many important decisions, including what type of business entity to establish. Formal business structures offer legal protection and sometimes even tax benefits to entrepreneurs.
Many people with plans for a business choose to form either a limited liability company (LLC) or a corporation. Illinois allows people to establish both S corporations and C corporations in addition to LLCs. Those interested in minimizing their tax obligations may need to carefully consider their plans for the business as they choose the entity type to establish.
LLCs are popular for a reason
The profits generated by an LLC are subject to the 15.3% self-employment tax rate for Social Security and Medicare. However, they are relatively straightforward to form and are therefore beneficial for people who haven’t yet begun operating the business and who anticipate a long grind before the company is in the black. Income tax returns for LLCs are generally simpler than those for corporations. Further, they don’t have the same payroll and reporting obligations as a corporation might.
Many people choose to create an LLC but elect S-corporation status for tax purposes. This solution allows them to divide income into a reasonable salary that they pay tax on as an individual and shareholder distributions, which are not subject to self-employment taxes.
The pass-through earnings are also subject to an Illinois individual income tax rate of 4.95%. Some companies may benefit from this structure. However, they may face a long-term limitation if they want to take the company public. S-corporations generally can only have 100 shareholders, and those shareholders must be residents or citizens of the United States.
Creating a C-corporation can be beneficial in cases where the goal is to either eventually have an initial public offering (IPO) or raise venture capital. C-corporations are subject to a 7% corporate tax rate in Illinois. They are subject to a flat federal corporate tax rate of 21% on all taxable income. Shareholders must also pay income tax on any dividends that they receive.
Every business plan requires a slightly different approach to tax minimization and optimal founder protection. Working closely with a business law attorney can help those hoping to start a company in Illinois choose the best option given their current circumstances and long-term goals.