Radhika Devarakonda is a licensed insurance agent, not a CPA, tax preparer, or attorney. This page describes categories and concepts only. It contains no strategy recommendations and is not tax advice.
Legal structure and tax status are two different things
This is the most common confusion I hear. The entity you formed with the state — sole proprietorship, partnership, LLC, corporation — is a legal structure. How the IRS taxes that entity is a separate question, and some structures can elect among several treatments.
- Sole proprietorship. The simplest arrangement. Business income generally flows onto the owner’s personal return, and net earnings are generally subject to self-employment tax.
- Partnership. Income and deductions generally pass through to the partners, who report their shares individually.
- LLC. A state-law structure. For federal tax purposes it is generally treated as a sole proprietorship or partnership by default, with elections available to be treated otherwise.
- S corporation. A tax election rather than an entity type. It involves paying the owner reasonable compensation through payroll, with different treatment for remaining profit. It also adds payroll and filing obligations.
- C corporation. Taxed as a separate entity, with its own considerations around distributions to owners.
Which of these fits depends on your profit level, whether you have employees, your state, and your plans for the business. There is no structure that is best in general, and anyone who tells you otherwise without looking at your numbers is guessing.
Self-employment tax, briefly
Employees split Social Security and Medicare taxes with their employer. When you work for yourself, you are generally responsible for both halves — that is what self-employment tax refers to. It is a large, often unpleasant surprise in a first profitable year, and it is one reason owners look closely at entity elections once profits grow.
Retirement plan categories
Retirement plans are one of the few areas where a business decision and a personal tax outcome are directly connected. These are the categories, described neutrally:
- SEP IRA. Employer-funded, administratively simple. Contributions are generally made for eligible employees as well as the owner.
- SIMPLE IRA. Designed for smaller employers, allowing employee deferrals with required employer contributions and lower administrative overhead than a 401(k).
- Solo 401(k). Available to owner-only businesses (and often a spouse). Allows contributions in both an employee and an employer capacity.
- Traditional 401(k). The full employer plan. Most flexible in design, most administrative work, with nondiscrimination testing and compliance obligations.
- Defined benefit plans. Pension-style arrangements sometimes discussed for older owners with high, stable profits. Complex, and requiring actuarial work.
Contribution limits and eligibility rules change annually. Any figure you read in an article is potentially stale, which is why none appear here.
Expenses: the boring truth
Deductions are not a discount on things you wanted anyway. An expense is generally deductible when it is ordinary and necessary for the business, properly documented, and actually incurred for business purposes.
The owners who do best here are not aggressive; they are organized. Separate bank account, separate card, clean books, real records. Most of what a CPA can do for you is limited by the quality of what you hand them.
Where insurance enters the conversation
Business owners generally have to solve for continuity: what happens to the business if an owner or a key person dies or becomes unable to work, and how a buy-sell arrangement would actually be funded. Those are real business questions and they are inside my license to discuss in general terms.
The tax treatment of any of it — deductibility, who should own a policy, how proceeds are treated — is a CPA and attorney question, every time, with no exceptions.
A reasonable next step
Write down your entity type, your rough net profit, whether you have employees, and what retirement plan (if any) exists today. Take that page to a CPA. If you also want the continuity side explained in plain English, that is what a twenty-minute conversation is for.