How important is it for the new entrepreneur to pick the right entity structure for tax purposes?

The first thing to understand about this decision is that even if you’ve done nothing, by the mere fact that you are engaged in a business you are already a sole proprietorship. In tax this is known as your default classification. The reason that this is important is that from a tax perspective your classification is already determined and you do not need to worry about getting the entity structure rights before you start your business.

A sole proprietorship is filed on your schedule C of your form 1040. It tracks your revenue and expenses from your business and arrives at a profit. This profit is taxed at self-employment tax rates of 13.3% in 2012. This self-employment tax is in addition to your income tax. These taxes replace the employment tax deductions that are taken out of your paycheck. Employment taxes include Social Security and unemployment taxes. Self-employment taxes become a problem after profits are being generated in your business and changing your structure to optimize taxes become important after you are making at least $50,000 in profit in your sole proprietorship. As long as profits are low, the sole proprietorship offers an easy, flexible, low-cost, structure for your business.