Tax Time: Choosing Right Business Entity is Crucial for a Small Business Owner
Choosing the right business entity is one of the most important decisions a small business owner has to make. While many factors must be taken into account in making this choice, the tax implications of the various business structures are probably the most important consideration. Each business entity is subject to different tax rates, tax liabilities and tax reporting procedures, making entity selection the one of the most important elements of effective tax planning. Because the tax code for business is not only complex but constantly changing, the entity selection process may require the help of a competent tax professional.
- The business income must be reported on the Schedule C of the business owner’s personal income tax return.
- Sole proprietors are required to pay themselves a self-employment tax on company profits. For 2013, this tax rate was 15.3 % on the first $113,700 of profit, 18.2% for profits between $113,700 and $200,000 and 19.1% for profits in excess of $200,000. These taxes must be paid even if the profits are invested back in the company.
- Although the full amount of the self employment tax must be paid by means of quarterly tax payments, 50 % of the amount paid can deducted from the sole proprietor’s taxable income at tax time.
- A percentage of the business income (determined by percentage ownership of the company) must be reported on Schedule C of each partner’s personal income tax return.
- The partners must pay self-employment taxes on their share of the annual company profit. The rates for partnerships are the same as those outlined above for sole proprietorships. As is true for a sole-proprietorship, these taxes must be paid even if the profits are invested back in the company.
- Partners can deduct 50% of their self-employment tax contribution from their taxable income when they file their personal income tax return.
- Since the owners of a C Corporation and the corporation itself are considered to be separate entities, the corporation must file its own corporate tax return. In addition, the owners of a C Corporation must file their own personal tax returns.
- The profits of the corporation are taxed on the corporate return and again on each business owners’ personal return if the profits are distributed. If the profits are invested back into the business, they are only taxed once on the corporate return.
- The corporate tax rate is currently 35% for business incomes over a certain threshold.
- An S Corporation does not pay tax on company profits. Instead, the profits are passed through to the company owners based on their percentage ownership. Each owner must then report their share of the company profits on their personal tax return to be taxed at their individual income tax rate.
- Since the profits of an S Corporation are treated as a distribution, the owners do not have to pay the self-employment tax that is required of sole-proprietors and partners.
Limited Liability Company (LLC)
- By default, an LLC is taxed the same as a sole-proprietorship or a partnership, depending on the number of LLC owners.
- Active LLC owners must pay self-employment taxes at the same rates as sole proprietors and partners. However, inactive members may be exempt from paying these taxes.
- An LLC can elect to be treated like a corporation for tax purposes by filing IRS Form 8832.
If you have questions about the tax implications your business structure or are seeking any type of business tax or accounting services, our experienced professionals can provide you with the expertise you are looking for. To learn more about our full range of business tax and business accounting services visit us today at www.businesstaxpreparation.com. Contact us by email at firstname.lastname@example.org or by phone at (866) 676-9417 to receive a free, no obligation consultation.