“With great power there must also come great responsibility.” – Ben Parker
As you begin plotting what type of business yours will become, it’s good to look at how different structures will dictate what types of taxes you will pay and how high they could be.
The reality is that the benefit of having your name on your business’ front door comes with the burden of certain taxes. Don’t get discouraged. Whether you’re planning a small business or are flying solo, identifying the structure that will lend itself best to your operation is one of the smartest things you can do from the outset. Just also remember that if you change your business type, it will also change the amount in taxes you will pay.
Small Businesses
Your business structure determines which income tax return form you have to file. The most common forms of business are the sole proprietorship, partnership, corporation, and S corporation. A Limited Liability Company (LLC) is a business type allowed by state statute.
- Sole Proprietorships – A sole proprietor is someone who owns an unincorporated business by himself or herself.
- Partnerships – A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.
- Corporations – Subject to double tax, in forming a corporation, prospective shareholders exchange money, property, or both, for the corporation’s capital stock.
- S Corporations – While not technically different than a corporation, by making this election with the IRS, you can get the flow-through taxation of a partnership with the liability-limiting protections of a corporation. However, you’ll have less than 100 shareholders and will only offer one class of stock.
- Limited Liability Company (LLC) – Owners are called “members” and there can be single-member LLCs. There is no maximum amount of members. You receive the flow-through taxation of a partnership with the liability-limiting protections of a corporation.
Companies structured as corporations (not electing to be S-Corporations) are taxed higher tax rate structure than LLCs, partnerships and other tax-efficient business structures since they pay tax at the entity level (the corporation). Depending on the form of distribution, corporations pay tax at the shareholder level for the distribution and the shareholder who works in the business will be taxed at ordinary income rates. If tax rates are lowered for corporations, small businesses that are structured differently wouldn’t get the same tax advantages unless there were a parallel amendment to personal tax rates.
Some Quick Tips
For a majority of start-up situations, we recommend the founding investors consider either an LLC or an S Corp in order to achieve tax efficiency. If you’re starting from the ground up, one quick tip is that an LLC and an S corporation both have a very significant advantage in common – they both offer the founding shareholders a crucial tax efficiency by eliminating the problem of double taxation.
There are various ways to claim deductions and lessen your business’ taxable amounts. This includes home office deductions if you operate out of your residence – just be organized and honest when filing your claims.
Self-Employment Taxes Are Always Fun
If you own an unincorporated business or are a contractor who provides services to other businesses, then you are generally considered self-employed.
Self-employment taxes consist of Social Security and Medicare taxes primarily for individuals who work for themselves. Schedule SE 1040 is the form for you. It’s quite similar to the Social Security and Medicare taxes withheld from the pay of most wage earners on a W2.
You can deduct the employer-equivalent portion of your self-employment tax in figuring your adjusted gross income. This deduction only affects your income tax. It does not affect either your net earnings from self-employment or your self-employment tax.
Payroll Tax Strategies
Payroll taxes can cause inevitably huge headaches. You must complete and submit quarterly statements with Form 941. Running as a Schedule C corporation – which charts the profits and losses of an unincorporated business – increases your chances of being audited. The alternative is to file a corporate return.
No matter what your business structure, don’t ever skip out on paying your payroll taxes. We’ve discussed proper protocol for when you think you cannot pay payroll taxes and presented viable alternatives.
Contact Brinen & Associates with any questions regarding which tax approach is the right one for you and your business.