The effect of income taxes on the preference of organizational forms for small businesses in the United States

Small business owners in the United States can organize their businesses as corporations, where the business income is subject to double taxation, or as flow-through entities, where there is only a single tier of taxation. One might assume that the flow-through entity provides more favorable tax benefits. However, if the corporate tax rate is less than the business owner's individual tax rate, a corporation might actually provide more favorable tax benefits. This depends on several factors, including tax rates, the rate of return earned on the business' assets, and on the business owner's investment horizon. We analyze the optimal form, for United States federal income tax purposes, of organizing a small business and develop indifference curves to illustrate the situations where these organizational forms have equivalent tax consequences. The indifference curves allow the small business owner to quickly and more accurately assess the optimal organizational form. Non-tax concerns are also discussed, as well as the applicability of the analyses to other countries.