November 1st, 2022
Bookkeeping, accounting, and taxes can be very complicated if you don’t understand, not only the principles, but the laws associated with them. In order to determine how your business structure will impact your taxes, it is important to secure a professional to help you with these duties to lighten up your load, as well as ensuring that you are doing everything correctly and filing things according to the laws in your state. If your books are not correct, you could ultimately file your business income taxes incorrectly and receive fines. Your business will need to meet all federal, state, and local tax obligations to stay in good legal standing. Your business structure and location will influence which taxes your business has to pay, as explained in detail on SBA Website.
How you file your business taxes will depend on what type of business structure you have. There are four main types of structures: sole proprietorship, partnership, LLC, and S corporation. There are pros and cons to each business structure, so, let’s clarify the meaning of each of these types of businesses.
A sole proprietorship is a one–owner business. This owner is involved in many of the day-to-day operations. For a sole proprietorship, you will not be filing separate taxes for your business, instead, you will be recording your business income (and losses) on your personal tax returns. This means that you will pay taxes at your individual federal income tax rate. When filing taxes, you will fill out a specific form, 1040 and Schedule C, to list all of your business expenses and your gross revenue. Some items included will be overhead items, such as utilities, raw materials, marketing, and even write-offs of personal vehicles for business use. If you made profit a profit for the year, you will report income, but if you operated at a net loss, you can offset this with other earnings.
A partnership is a business agreement, including capital and property, with two or more owners. The owners’ duties should be detailed in the agreement. All of the owners will share the profits and losses of the business, in regards to what percentage they own (or contributed). A partnership is also considered a pass-through entity, meaning that the business would not pay its own taxes, but once again, each partner would pay their part of the business taxes through their personal taxes at their own tax rates. According to the Small Business Chronicles, it’s usually illegal to create a partnership agreement that assigns a higher percentage liability to a partner than the partner originally invested in the company.
Another very common type of business structure is LLC. An LLC protects its owner’s individual assets, because the owners cannot be held personally responsible for the business debts. AN LLC is typically also treated as a pass-through entity, where the LLC itself doesn’t pay taxes, but the owners pay taxes on their share of the profits. Since an LLC does not publicly sell shares, the owners are only taxed once on their personal company earnings. A benefit is that LLC owners can deduct their expenses and losses.
According to the IRS: Generally, an S corporation is exempt from federal income tax other than tax on certain capital gains and passive income. It is treated in the same way as a partnership, in that generally taxes are not paid at the corporate level. S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on corporate income. S corporations are responsible for tax on certain built-in gains and passive income at the entity level.
According to the IRS, a C-Corporation has a similar structure to an S-Corporation. A big difference between the two is C corporations provide limited liability protection to shareholders, who are called shareholders, meaning owners are typically not personally responsible for business debts and liabilities. C corporation is recognized as a separate taxpaying entity. A corporation conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders. The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. This creates a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any loss from the corporation.
In conclusion, how your taxes work will be dependent on your business structure. If you are a sole proprietor, you have less options than a corporation. There are pros and cons to each structure and you will just need to decide which structure best fits your business’ needs.
Even though we are based in Albany, NY, we offer our expertise in business accounting, bookkeeping, and tax preparation all across the United States.