Choosing the Right Business Structure as You Grow

The business structure that made sense when you launched your company may not be the best structure several years later. As revenue increases, employees are added and the value of the business grows, tax exposure and financial risk can change significantly.

Choosing an entity should therefore be viewed as an ongoing planning decision rather than something addressed only when the business is formed.

When Growth Changes the Equation

A sole proprietorship or single-member LLC may provide simplicity during a company’s early stages. As profitability grows, however, owners may begin evaluating whether another tax structure provides advantages.

An LLC is a state-law business structure, but it can have different federal tax classifications depending on ownership and elections made with the IRS. For example, an eligible LLC may elect to be taxed as an S corporation rather than remaining under its default tax classification.

The appropriate structure depends on much more than revenue. Business owners should consider:

• Profitability and expected future growth
• Number and type of owners
• Payroll and compensation requirements
• Liability and operational risks
• Plans to raise capital, add partners or eventually sell the business

As these factors evolve, revisiting the entity structure can identify opportunities as well as potential problems.

Tax Efficiency Is Only Part of the Decision

S corporation taxation can be attractive for some profitable businesses because income generally passes through to shareholders for federal tax purposes. However, shareholder-employees who provide services to the business must receive reasonable compensation before non-wage distributions are made.

A C corporation operates differently as a separate federal taxpayer. Corporate profits can potentially be taxed at the entity level and again when distributed to shareholders as dividends. Yet C corporation status may make sense in certain situations involving outside investment, ownership goals or longer-term business strategy.

This is why choosing an entity based solely on the lowest current tax bill can be shortsighted. Administrative requirements, liability protection, compensation strategy and eventual exit plans also deserve consideration.

Your Structure Should Support Where You’re Going

Business owners should periodically review their entity choice as part of broader tax and financial planning. A structure designed for a small startup may become inefficient as the company develops into a valuable asset.

The best time to evaluate these questions is before a major transition. Bringing in investors, expanding into new markets, experiencing a significant increase in profitability or preparing for a future sale can all warrant another look at how the business is structured.

At Illumination Wealth, we help business owners coordinate entity decisions with their personal wealth, tax strategy and long-term goals. As the business evolves, the structure supporting it should evolve thoughtfully as well. Contact us today to consult with one of our leading business advisors.