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Tax implications of business entity choices

Masked business woman holding open sign

The Great Resignation created by folks deciding not to return to their jobs after extended COVID-19 absences has led to a lot of new businesses.

That means there a many new bosses out there, most of them dealing with a different part of the Internal Revenue Service for the first time.

As business owners, they potentially face new types of taxes. Exactly which taxes depend largely on how their new company is established. That's why selection of a business entity is a major tax decision.

Business entity options: As part of 2021's National Small Business Week, sponsored annually by the Small Business Administration, the IRS reminds entrepreneurs of the most common business structures:

  • Sole proprietorship — An unincorporated business owned by an individual. There's no distinction between the taxpayer and their business.
  • Partnership — An unincorporated business with ownership shared between two or more people.
  • Corporation — Also known as a C corporation. It's a separate entity owned by shareholders.
  • S Corporation — A corporation that elects to pass corporate income, losses, deductions and credits through to the shareholders.
  • Limited Liability Company — A business structure allowed by state statute.

If you are starting a business, your tax adviser — you did hire one the minute you decided to strike out on your own, right? — can help you determine which entity is best for your new endeavor.

SBA entity comparisons: You also can do a little homework before that discussion by checking out the SBA's special web page on choosing a business structure.

And here's the agency's table comparing the business entities cited by the IRS and a few more.

Business structure

Ownership

Liability

Taxes

Sole proprietorship

One person

Unlimited personal liability

Personal tax only

Partnerships

Two or more people

Unlimited personal liability unless structured as a limited partnership

Self-employment tax (except for limited partners)

Personal tax

Limited liability company (LLC)

One or more people

Owners are not personally liable

Self-employment tax

Personal tax or corporate tax

Corporation -
C corp

One or more people

Owners are not personally liable

Corporate tax

Corporation -
S corp

One or more people, but no more than 100, and all must be U.S. citizens

Owners are not personally liable

Personal tax

Corporation -
B corp

One or more people

Owners are not personally liable

Corporate tax

Corporation -
Nonprofit

One or more people

Owners are not personally liable

Tax-exempt, but corporate profits can't be distributed


Business taxes from your new entity: Once you've selected the form of business, that will determine what taxes you/your new company must pay and how you pay them.

The five general types of business taxes are:

  • Income Tax — All businesses except partnerships must file an annual income tax return. Partnerships file an information return. The form you use depends on how your business is organized. 
  • Estimated Taxes — The federal income tax is a pay-as-you-go tax. You must pay the tax as you earn or receive income during the year. Generally, business must pay taxes on income, including self-employment tax, by making regular payments of estimated tax during the year.
  • Self-Employment Tax — Self-employment tax (SE tax) is how individuals who work for themselves pay into the Social Security and Medicare programs. Generally, you must pay SE tax and file Schedule SE (Form 1040 or 1040-SR) if your net earnings from self-employment are $400 or more. There are special rules and exceptions for a church or a qualified church-controlled organization, aliens, fishing crew members, notary public, state or local government employees, foreign government, or international organization employees.  This is just one of the reasons you need a tax adviser.
  • Employment Taxes — If you have employees, you as the employer have certain employment tax responsibilities, including taxes you must pay and forms you must file, aka payroll taxes. Employment taxes include workers' Social security and Medicare taxes, federal and state income tax withholding, and federal unemployment (FUTA) tax.
  • Excise Tax — You might have to pay and file certain form for various excise taxes if you manufacture or sell certain products; operate certain kinds of businesses; use various kinds of equipment, facilities, or products; or receive payment for certain services. Again, hire and/or consult your tax adviser.

Finally, don't forget about state business requirements, from tax to licensing to employment requirements. This is yet another reason why every new business owner needs a tax specialist.

Yes, starting your own business is lot of added work. But for most, it's worth it.

Just make sure you're prepared and have a good support, tax and otherwise, system in place.

You also might find these items of interest:

 

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