Asked about 1 year ago - Joliet, IL
FlagIf I owe $160,000 in student loans (I was disabled), and am starting a small business, what type of business structure should the business have, since student loan payments are based on income? I'm looking at a regular corporation or an s-corp for a fitness business. From what I'm reading, s-corps taxation is a little confusing. i don't know if the students loan processor will look at all income or at net income, income after profits, losses, and business investments, such as equipment.
As between a regular corporation (known as a "c-corporation" in tax lingo) and an s-corporation, from a tax perspective an s-corporation is generally the more tax-efficient structure to use - that is, the total tax on the income earned from the business is generally lower with an s-corporation because there is only one level of tax - all of the s-corporation's income is taxed to the shareholders, there is no separate corporate tax paid by the corporation (generally speaking) - whereas a c-corporation must pay its own corporate income tax.
The taxation of s-corporations probably does look strange the first time you see it, but basically it is almost the same as the taxation of partnerships; in very brief terms, the shareholders report their share of the corporation's income on their personal returns and claim deductions for their share of the corporation's business expenses on their personal returns. In your case, if you were the sole shareholder, the situation would be even simpler and basically you would be reporting all of the corporation's items of income and expense as your own.
An LLC might be another option as an entity to hold your business; however, if you were the sole member of the LLC then by default the LLC would be disregarded for income tax purposes and all of the income and expenses of the business would be reported on a Schedule C attached to your personal federal income tax return (you could if you wanted to elect to treat the LLC as a corporation for tax purposes, but then we'd just be back to the same discussion about c-corporation versus s-corporation above).
With respect to your immediate question: whether the business structure you chose would affect the amount of income on which your student loan payments would be based, the only entity choice that would allow you to report on your personal tax returns income that was less than the total amount of income earned by the business itself would be a c-corporation; however, the trade-off for that would be paying much higher taxes on the income from the business that you left in the c-corporation.
To give you a very, very simple hypothetical, assume the business earns $100,000 in net income for Year 1. Also, for simplicity's sake, assume that the personal income tax rate is 25% and the corporate income tax rate is 30%.
If you were using an s-corporation, you would have to report all $100,000 of net income on your personal income tax return and would pay $25,000 of income tax on that net income. The s-corporation would not pay any corporate income tax. You would be left with $75,000 of after-tax cash, either in the corporation's bank account or your bank account.
If you were using a c-corporation the situation gets a little more difficult because how you take the money out of the corporation will affect how it gets treated for income tax purposes on your tax return. However, to take the simplest case, assume that you pull out all of the cash (net of taxes) as a dividend in Year 1. Since dividends are not deductible, the corporation would pay $30,000 of corporate income tax, leaving you with $70,000 of cash, which you would then have to report as dividend income and pay $17,500 of tax on, leaving you with $52,500 of after-tax cash sitting in your bank account.
Comparing these two situations, you can see that you report less income on your personal tax return ($100k versus $70k), which might affect your student loan payment, but you would also be left with substantially less cash after taxes, so much so - $22,500 more with the s-corporation - that you could probably still pay a higher student loan payment based on the higher income from the s-corporation and still end up with more cash than if you went with a c-corporation and took all the money out as a dividend.
Please keep in mind that this is a very artificial example. I've run out of space so I'll end my answer here. If you want more detail, please let me know.
If you're talking about payments based on income, they only thing they look at is your AGI on your personal taxes. The structure of your corporation will make little difference, it's the net that shows up as taxable income that will influence your student loan payment. An LLC may work just as well as incorporating. Keep good accounting and attribute whatever you can to the business. Again, it is the net that is considered, bottom line of schedule C. Best advice is to talk to a CPA or small business attorney to discuss tax liability based upon structure. I think you'll find an LLC the simplest and best for a small business.
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