One of the first things you must do to officially establish your business is to select a corporate structure. If you’re setting up a business for the first time, it’s important that you consider all of the ways in which your business structure can impact your company, not only from a legal standpoint, but from a financial standpoint as well. This article will provide you with a quick look at how each corporate structure can impact the way your company is taxed. Be sure to consider this factor, as well as the other pros and cons, when choosing your business structure and registering your business.
While there are many different types of corporations out there, most of them are taxed in a similar manner. The IRS recognizes most corporations, including C corps, as a separate tax-paying entity. This means that the company itself is taxed on its profits, can take business deductions, and so on. This also means that most types of corporations will be taxed twice: Your business will be taxed on its profits, and the shareholders (including you) will be taxed on their income when they receive their dividends.
It is important to note that non-profit organizations are considered a corporation in terms of business structures. However, they are taxed very differently from other types of corporations. If your new business is a non-profit, you can register with the IRS for a tax-exempt status. However, there are very strict requirements regarding how you can use your profits if you want to maintain your status as a tax-exempt non-profit organization.
Corporations require very detailed record-keeping and reports, so if you decide to register under this business designation, you should work with a professional business accountant to ensure that your financial records are up to standard.
For many first-time business owners, sole proprietorship is a popular business designation. This type of business is easy to set up and can allow you to test out your business idea before establishing a more formal business structure. They’re also much simpler to manage from a tax standpoint, because your business’s profits and losses are typically reported on your personal tax return; you simply fill out a Schedule C and Form 1040 and file them along with the rest of your return, and your business’s taxes are complete.
There are two types of partnerships that are commonly used as business designations: limited partnerships (LPs) and limited liability partnerships (LLPs). The main difference between these two is related to legal liability. From a tax standpoint, however, they’re essentially handled the same way. Partnerships are taxed on a pass-through basis. This means that the business’s profits and losses are passed along to the business partners.
Each year, every partner will receive a K-1 tax form that shows the amount of income or loss to be reported on their individual tax returns. The partners will then use a Schedule E to report their share of the profit or loss and include when filing their personal return. The reported income is subject to each partner’s individual income tax bracket, as well as a self-employment tax. Losses can often be included as a deduction.
If your partnership has any “limited partners,” there is a slight difference in how their share of the profit or loss is handled. A limited partner reports their share of the business as a passive loss or passive income. Passive income is not subject to self-employment taxes, but there are limits in how passive losses can be used on your return as well.
Limited Liability Companies
The final category for business designations is limited liability companies (LLCs). Similar to partnerships, LLCs are pass-through entities. However, because an LLC can have a single owner or multiple business partners, they can be taxed in different ways.
Single-member LLCs are taxed in the same manner as sole proprietorships; the business owner reports the business’s income using a Schedule C and Form 1040, and files it with their personal tax return. For multiple-member LLCs, profits and losses are passed through to all partners; partners receive a Schedule K-1 and report the profits and losses on a Schedule E, alongside their personal tax returns.
As we mentioned, taxation is only one factor to keep in mind when selecting a corporate structure for your new business. If you have any questions regarding which designation is right for your company, or if you need professional accounting services for your business, contact Witts CPA today to schedule an appointment with one of our expert business accountants.