By Emily Wright
It can be argued that the most significant step in starting your business is selecting the correct tax classification, most of which are clearly defined and simple to understand…if you work for the IRS. For the rest of us, it’s not so simple. What are they? What do they mean? How does this affect me going forward? Thankfully, I am here to shed some light on each option and touch on the tax benefits and drawbacks of each classification.
- Sole Proprietorship/Partnership – These are the two simplest options. The catch is that that these classifications are not recognized as a legal entity. All the revenues, expenses, and debts fall squarely on the owners’ shoulders, meaning personal property could be used to settle debts. Filing taxes is a simple matter. The owners and the business are considered one entity. You simply include the proper tax forms with your 1040 tax filings. The Schedule C is for sole owners. While the Schedule K-1 is used to split the revenue among the owners by their respective percentages of ownership. Be aware of your tax liability during the year and save or withhold revenue accordingly. No one likes to be surprised by a hefty tax bill at the end of the year, which includes a self-employment tax. It’s a gift worse than coal in your stocking.
- C/S Corporation – Unlike the prior options, Corporations are considered a legal entity. The owners are free of its debts while enjoying the profits. Corporations also enjoy a lower tax rate than most individual tax payers. However, there is the major drawback of double taxation. Simply put, a C Corporation must pay taxes on its income. Then the shareholders must pay taxes on dividends and capital gains. If an owner also owns shares within the company, you will effectively be taxed twice. However, one way around this option is to form an S Corporation, which itself isn’t taxed, but has its profits or losses passed on to the shareholder, who then pays taxes on their own returns.
- Limited Liability Corporation – An LLC nicely blends the freedom of a proprietorship/partnership while providing the personal protection of a corporation. When it comes to tax time you will see a flow very much like that of the proprietorship/partnership. All income and losses pass through to the owners. One thing to keep in mind though, is that these potential profits will be taxed at your personal tax rate, which is much higher than the corporate tax rate.
This roughly covers all the business designations and what they entail. Small businesses tend to lean toward sole proprietorship, partnership or limited liability corporations. S Corporation is also a viable option, though it is tougher to set up, making it a less desirable option for small business owners, at least initially. In the end, it takes self-education on options available and picking the one that suits your company the best. To that end, I hope I was able to help guide you down the right path of inquiry.
Emily Wright, The Bookies – Small Business Accounting Solutions
We believe that the small businesses of middle Tennessee are a crucial part of our community and we want to do everything we can to help you succeed. That success can be nurtured by using an affordable solution to your accounting needs. We have the knowledge and experience to take the bookkeeping burden off your shoulders. The diligence to give you peace of mind that the infrastructure of your business is secure. The assurance that you can focus on the fun parts of running your company, while we handle the rest. Our passion is to help you achieve yours, with your sanity intact. Contact us today and let the fun begin!
Learn more about The Bookies on Linkedin.