Tax Law ✦ Entities
LLC, S Corp, or C Corp? Decide It on the Numbers.
The entity you choose sets your self-employment tax, your ability to take losses, how a sale will be taxed, and whether an SBA lender or an investor will deal with you. For Colorado businesses the state side is simple, which puts all the weight on getting the federal structure right. North Star Law Firm models the choice, files the elections, and drafts the tax provisions.
Overview
The decision, and what rides on it
A Colorado business can be a sole proprietorship, a single-member LLC taxed as a disregarded entity, a partnership, an LLC or corporation taxed as an S corporation, or a C corporation. Each choice sets the rate on operating profit, the treatment of owner compensation and distributions, the deductibility of losses and fringe benefits, the exposure of personal assets, and the tax on an eventual sale. Colorado adds little friction: no franchise tax, a flat income tax that follows the federal computation, an optional entity-level tax election for pass-throughs, and inexpensive Secretary of State filings. We run the comparison on your actual projections, choose, file the elections, and document the reasons.
- Comparison of entity types on your projected numbers
- Form 2553 S elections and Form 8832 classification elections, filed and confirmed
- Reasonable-compensation analysis for S corporation owners
- Section 1202 qualified small business stock planning
- Operating and shareholder agreement tax provisions
- Colorado SALT Parity Act election evaluated annually
- Multi-owner allocations under § 704(b)
- Late election relief when a prior filing was missed
Comparison
How the choices differ for a Colorado owner
| Sole prop / disregarded LLC | Partnership LLC | S corporation | C corporation | |
|---|---|---|---|---|
| Federal tax on profit | Owner’s individual rates plus 15.3% self-employment tax | Owners’ individual rates plus self-employment tax on active partners | Owners’ individual rates; payroll tax on salary only | 21% at the entity; dividends taxed again to owners |
| Colorado tax | Flat rate on the owner’s return | Flat rate on owners’ returns, or at the entity under the PTE election | Flat rate on owners’ returns, or at the entity under the PTE election | Flat corporate rate at the entity |
| Owner compensation | Draws; no payroll | Guaranteed payments | Reasonable salary required through payroll | Salary through payroll |
| Losses | Flow to owner, subject to basis and passive rules | Flow to owners, subject to basis and passive rules | Flow to owners, limited to stock and debt basis | Stay in the corporation |
| Sale of the business | Asset sale; ordinary income on some assets | Asset sale or interest sale | Asset or stock sale; one layer of tax | Stock sale can qualify for § 1202 exclusion; asset sale is taxed twice |
The Attorney-CPA Difference
Entity choice is a projection, and projections are what CPAs do.
The right answer depends on profit, on how much the owner takes out, on whether there are losses to use, and on how the exit will happen. Those are numbers, and we run them before we draft anything. Because we also handle the enforcement side, we know what the IRS looks for in an S corporation audit and we set the salary and the documentation so the election survives one.
- Entity comparison built from your projections
- Elections filed with proof and calendared
- Reasonable compensation set with a documented method
- Agreements drafted to match the tax structure
- Annual review of the Colorado PTE election
Questions & Answers
Entity Selection & Structuring questions, answered
Should my Colorado business be an S corporation?
Usually once net profit is high enough that the payroll tax savings exceed the cost of running payroll and a separate return, often somewhere above $60,000 to $80,000 of profit. The election requires paying yourself a reasonable salary, and the IRS audits S corporations for that. We model the break-even for your numbers before recommending it.
Does Colorado tax S corporations or LLCs at the entity level?
Only if you elect it. Colorado has no franchise tax and no entity-level tax on pass-throughs by default. The SALT Parity Act election lets a partnership or S corporation pay the flat Colorado tax at the entity level so the owners get a full federal deduction for it, which is worth doing for owners whose state tax would otherwise be capped on Schedule A.
What about a C corporation?
The 21 percent federal rate plus Colorado’s flat corporate rate makes the C corporation attractive for businesses that reinvest profits, and qualified small business stock under I.R.C. § 1202 can make a future sale largely tax-free. It is the wrong answer for a business that distributes most of its profit, because of the second layer of tax on dividends. The decision is a projection, not a rule of thumb.
Do I need an operating agreement?
Yes, and it needs to be consistent with the tax structure. Multi-member LLC agreements set the capital account and allocation rules the IRS tests under § 704(b); S corporation agreements must not create a second class of stock. We draft or review the tax provisions and coordinate the state-law drafting with Colorado-licensed counsel where required.
Can I change my entity later?
Often, but not always cheaply. An LLC can elect S or C status prospectively with no tax cost. Converting a C corporation to an S corporation triggers built-in gains exposure for five years. Going the other way, from S to C, is easy; returning to S has a five-year wait. Choosing well at formation avoids most of this.
Plan the tax before the transaction, not after.
A free consultation with an attorney-CPA who can draft the structure and run the numbers in the same meeting.