There’s nothing simple about starting and owning a business. If you’re a small-business owner, you’ve probably heard of the 2018 tax bill known as the “Tax Cuts and Jobs Act.” This bill has reformed corporate taxes in the United States, especially for small businesses, making this one of the best times to start the business you have been dreaming of.
Choices are everywhere in business plans, company names, pricing, employees, benefits and office space. But first, in order to register your company with state and federal agencies, you’ll need to choose a business structure, and this choice can have consequences that are not immediately clear.
A business’s structure is basically the way it’s organized. An organizational structure defines how activities such as task allocation, coordination and supervision are directed toward the achievement of organizational aims. Organizations need to be efficient, flexible, innovative and caring in order to achieve a sustainable competitive advantage. Here are the most common IRS-recognized business structures and how they affect your taxes.
A sole proprietorship is the easiest business type to form, and it puts you in total control. In a Sole Proprietorship, there is no distinction between you and the business, meaning the company and the owner are the same legal entity and the owner is personally liable for any business debts. The business owner is entitled to all profits. If you don’t file paperwork with the government to claim a particular business structure, the IRS automatically assumes your business is a sole proprietorship. That means your individual assets, business assets, and debts are lumped together.
In a sole proprietorship, business and personal taxes are not separate because your income is your income. This business can lead to some advantages such as:
• Lowest tax rates of business structures
• Quick and inexpensive to form
• You have complete control over your business
• You only have to file taxes once.
There are also some tax disadvantages of a sole proprietorship including:
• Unlimited personal liability
• Hard to raise money
There are also some additional requirements including the self-employment tax. If your business is a sole proprietorship, you are responsible for the portion of social security and Medicare tax paid by an employer.
This business type is structured like a sole proprietorship except with an unlimited number of owners. The two most common kinds of partnerships, limited partnerships (LP) and limited liability partnerships (LLP), are the simplest business structures if two or more people are running a business together. General Partnerships and Joint Ventures also exist under this type of structure.
Partners must file a tax return of income for their business and file taxes personally on their share of income or losses. The advantages of partnerships include:
• A quick and inexpensive form
• Easy to acquire funding
• Number of partners can change over time
While also facing some disadvantages such as:
• Lack of complete control for an individual
• Personally liable for the debt of other partners
• Disputes between partners are common
Limited Liability Company (LLC)
LLCs help separate personal assets and liabilities from business ones, reducing your personal risk if something bad happens to your business. Your profits and losses can pass through to your personal income without facing corporate taxes. However, In an LLC, members are considered self-employed and must pay self-employment taxes. In addition, several states require additional state taxes.
Some advantages of a Limited Liability Company include:
• Limited liability of a corporation
• Operational flexibility of a partnership
• Easier to raise money
• Fewer restrictions on profit sharing
• Surplus earnings not taxed
A C Corporation is a separate legal entity owned b shareholders. Unlike a Limited Partnership and Limited Liability Partnership, C Corps completely separate personal and business assets and liabilities. They offer the highest protection for their owners but require more reporting, paperwork and record keeping.
They are required to pay federal state, and sometimes local taxes as well as subject to income tax leading to double taxation at times. C corps are first taxes when the corporation makes a profit and again when dividends are paid to shareholders. Below we have listed some advantages of a C corporation:
• Limited Liability
• Ability to generate capital
• Corporate taxes are often lower than personal taxes.
• Some disadvantages of a C Corporation include the following:
• Time and money spent on start-up and administrative costs
• Double taxing in some cases
• Additional paperwork
• Less control for individuals
C Corporations are great for a business that sells products, has a storefront and employees, and may or may not have a warehouse where it keeps its inventory. Due to the tax treatment on the sale of assets, C corps don’t work well with businesses that want to hold appreciating assets such as real estate.
An S corporation allows profits and losses to be passed through to personal tax returns. An S corporation is structured to avoid double taxation, like what happens in a C corporation. S corporations allow profits, and some losses, to pass directly through the owners’ personal income without being subject to corporate tax rates.
Owners treat taxes as they would a partnership or sole proprietorship. Shareholders are taxed when dividends are paid. The remaining income is paid to the owner as distribution which is taxed at a lower rate. The advantages of S Corporations are:
• Limited Liability
• Tax Savings
• Shareholders are separate from the company
The disadvantages of S Corporations include:
• Stricter operational processes
• Shareholder Compensation requirements
• Foreign ownership of shares is prohibited
• More than 100 shareholders is not permitted
Limitless Investment and Capital Tax Services
Limitless Investment and Capital Certified Public Accountants have the expertise to assist your small business with tax preparation and assistance with any business structure. Let our experts handle your taxes and help your company reduce your tax liability this year. We are a trusted CPA firm with dozens of years of experience and a deep understanding of each business structure. Get in touch today!