Is the entity used to operate your firearms business costing you money? Although many of the tax law’s provisions apply to all business entities, some areas of the law specifically target each type of entity. Thus, choosing among the various entities can result in significant differences in federal income tax treatment.

The Bureau of Alcohol, Tobacco, Firearms and Explosives (ATF) requires a business structure, and the Federal Firearms License (FFL) is issued to the business entity, not the individual. While a sole proprietorship can have an FFL, forming a Limited Liability Company (LLC) or Corporation is usually the best course of action to protect the owner’s personal assets from business liabilities. But, there are also other benefits as well as other options.

 

The Tax Question

While the Limited Liability Company (LLC) is the most popular today, for tax purposes, the main forms of business enterprise are the regular, so-called C corporation, its pass-through small business cousin, the S corporation, a partnership, those LLCs or an increasingly rare sole proprietorship.

Of all business entities, however, it is the so-called regular or C corporation that takes the biggest tax bite. The earnings of an incorporated tactical retailer are actually taxed twice. First, a corporate income tax is imposed on the operation’s net earnings, and then, after the earnings are distributed to shareholders as dividends, each shareholder must pay taxes on his or her share of the dividends.

Naturally, a corporation can reduce or even eliminate its federal income tax liability by distributing its income as salary to shareholder-employees who actually perform valuable services for the incorporated tactical retailer. Although this can reduce taxation at the corporate level, those who receive profits from a corporation in exchange for services must pay tax on the amount received, since it is considered salary for tax purposes.

This scheme of taxation differs radically from that applied to S corporations, partnerships, LLCs and sole proprietorships. These entities, often referred to as “pass-through” entities, do not pay an entity-level tax on their earnings. Only the owners of these entities are taxed on their share of the entity’s earnings.

 

Pass-Through Entities

Pass-through businesses (also known as disregarded entities), such as sole proprietorships, partnerships, LLCs and S corporations, don’t pay a corporate income tax. Instead, the tactical retailer’s net business income “passes through” to the owner’s individual tax bill.

A unique type of corporation, the S corporation, is a business entity that passes taxable income, losses, deductions and tax credits through to the tactical sports products operation’s shareholders. S corporations are popular largely because of their favorable tax advantages and liability protection.

Similar to a corporation, the Limited Liability Company or LLC, is formed with its own legal existence — separate from its founders and “members,” as LLC owners are called. As is the case with corporations, filing with the state government is a necessity, but unlike corporation filings, the LLC’s operating information is not public.

Often preferred for firearms-related businesses, an LLC separates the personal assets of its owner(s) from business assets. Corporations, regular C corporations or S corporations provide personal asset protection by creating a legal distinction between the business and its owner(s). Each type of entity — partnership or LLC, S corporation, regular C corporation or sole proprietorship — has its benefits and drawbacks.

 

Qualified Business Income

The owners, partners and shareholders of sole proprietorships, partnerships, LLCs and S corporations may be able ignore part of their business’s income. Section 199A of the tax law created the Qualified Business Income (QBI) deduction, a deduction that allows eligible, self-employed small business owners to deduct up to 20% of their qualified business income.

The One Big Beautiful Bill Act (OBBBA) made the 20% deduction for pass-through businesses, such as sole proprietorships, partnerships and S corporations, permanent. Small, pass-through businesses can deduct up to 20% of their qualified business income, (plus 20% of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income).

The OBBBA also created a new inflation-adjusted minimum deduction of $400 for taxpayers with at least $1,000 in qualified business income to ensure eligible small business owners can access an enhanced baseline deduction.

Naturally, the QBI deduction is subject to limitations, such as the type of business and the amount of W-2 wages paid by the business. In general, total taxable income must be under $191,950 for single filers and $383,900 for joint filers to qualify. If over that limit, the rules are quite complicated for a full or partial deduction.

 

Liability

One of the main reasons tactical retailers select an entity for their business is to avoid personal liability for the business’s debts. Sole proprietorships, for instance, offer the least amount of protection from liability, since the owner is personally liable for any and all liabilities or debts incurred by the business.

The only difference between a sole proprietorship and a partnership is that partners can be held liable for the liabilities incurred by someone else, with each partner liable for the liabilities of the business.

Corporations and LLCs, as mentioned, have their own legal existence, with each owning the business, its assets, debts and liabilities. The liability for shareholders or members (the owners of the LLC or corporation) is limited to their investment.

When it comes to liabilities incurred by any business entity, every tactical retailer has the option of protective insurance. A Business Owner’s Policy (BOP) protects the owners of a business from liability claims and lawsuits. It also safeguards the operation’s buildings, equipment and inventory and covers the owners financially if the operation unexpectedly shuts down as the result of a covered loss.

 

Don’t Forget the ATF

For a simple trade name change (the “doing business as” DBA) that does not involve a new legal entity, sending the original license to the ATF Federal Firearms Licensing Center for an endorsement of the trade name change is all that is required.

Unfortunately, because a Federal Firearms License (FFL) cannot be transferred between different legal entities, in order for any tactical retailer to change the entity of their business, they must apply for a new license. That means treating any change in business structure as if it were a new business.

That process usually involves registering the new entity with the state where it conducts business, obtaining a new employer Identification Number from the IRS, submitting a new license application (ATF Form 7), providing new fingerprints and photographs and undergoing a new licensing review. Plus, any existing inventory or firearms must be legally transferred from the business’s old license to the new one.

 

Don’t Forget the State

Every taxing jurisdiction wants a say in how business is conducted. Thus, remaining in good standing with the state in which the operation is incorporated or registered as a partnership or LLC can be critical.

Should the state suspend or revoke the operation’s right to do business as a particular type of entity, the IRS and the tax court will agree that the operation’s powers and privileges were suspended and deny any challenge the decisions of either.

 

Changing Entities in Mid-Stream

Changing business structures used to be rare thanks to the limited options. Today, an LLC can choose to be taxed like a regular corporation by simply filing a form with the IRS. In fact, to change a tactical retailer’s entity classification, either Form 8832 or Form 2553, depending on the specific change, is needed.

• Form 8832, Entity Classification Election, is used to change to a regular corporation, a partnership or so-called “disregarded” entity (if a single owner) by LLCs and partnerships.
• Form 2553, Election by a Small Business Corporation, is used by incorporated businesses and LLCs to elect to be taxed as an S corporation. Naturally, in order to qualify, the business must meet specific requirements, such as being a domestic entity and having no more than 100 shareholders.

Depending on the type of switch and the tactical retailer’s situation, a substantial tax bill might result. For example, the disolution liquidation process may create a tax liability for everyone receiving an interest in the business. Fortunately, a direct conversion typically does not incur additional tax liability.

 

Decisions and More Decisions

One of the drawbacks of a C (regular) corporation is that the salary of shareholders can be challenged as excessive because the IRS thinks the corporation is paying too high a salary to avoid paying dividends. Changing the tax status of a business can, potentially, reduce the tax burden, especially for LLCs electing to be taxed like a regular, incorporated business.

On the other hand, an LLC can elect to be taxed as a corporation where only the salary of the owner is subject to FICA taxes. If this election is made, the LLC owner pays self-employment taxes, the equivalent of the employer’s and the employee’s share of FICA on all of the business’s net earnings.

Whether the business is operated as a sole proprietorship, LLC or another business structure, it may be time to chose a new entity. To help with this decision-making process, professional advice is strongly recommended.