How Business Structure Affects Taxes

How-Business-Structure-Affects-Taxes

Share this infographic on your site!

How Business Structure Affects Taxes

Pick Your Poison

What type of business do you have/want/plan to make?

Sole Proprietorship: The one man show
Partnership: The dynamic duo
Limited Liability Corporation: Something you can get behind
Cooperative: By the people for the people
C Corporation: The big money makers
S Corporation: LLC plus

The choice can be important when it comes to taxes.

Sole Proprietorship

Structure:
There is no distinction between you and the business.
You are entitled to all profits
And responsible for all business
Debts
Losses
And Liabilities

Taxes:
Business and personal taxes are not separate.
Because sole proprietorship income is your income.
Forms:
Schedule C
And Form 1040
Additional Requirements:
Self-employment tax: the portion of social security and medicare tax paid by an employer.
Estimated taxes: the method through which one pays self-employment taxes throughout the year.

Advantages:
Lowest tax rates of business structures
Quick and Inexpensive to form
You have complete control over your business
Only file taxes Once

Disadvantages:
Unlimited personal liability
Hard to raise money

There are many more sole proprietorships than any other form of business:

Number of registered businesses by type:
Sole Proprietorship: 22.6 million
Corporations: 5.8 million
Partnerships: 3.1 million

Yet corporations account for a vast majority of income:

Net income by business type:
Sole Proprietorship: $265 billion
Partnerships: $458 billion
Corporations: $984 billion

Partnerships

Structure:
General:

2 of more people share ownership
Sharing profits and losses

3 Types:
General Partnerships:
Equal division in profits, liability, and management.
Limited Partnerships:
Limited liability and input allocated depending on a partner’s share of ownership.
Joint Ventures:
Time limited general partnership (above).

Taxes:
Partners must file a return of income for their business
And file taxes personally on their share of income or losses.

Advantages:
Quick and inexpensive to form
Easy to acquire funding
Number of partners can change over time

Disadvantages:
Lack of complete control for an individual
Personally liable for debt of other partners
Disputes between partners are common

Limited Liability Company

Structure:
Hybrid between a corporation and a partnership
Owners are called “members”
Which can be a single individual
A partnership
Or Many members
Profits and Losses are “passed through” to members.

Setting one up:

1.) Choose a name
2.) File Articles of Organization
3.) Create an operating agreement
4.) Obtain Licenses and Permits
5.) Announce your business (in some states)
Then: Prosper!

Taxes:
Partners file taxes on their personal returns
But several states require additional state taxes.
Forms:
Personal Tax Forms
Or, Form 8832 to file as a business

Advantages:
Limited liability of a corporation
Operational flexibility of a partnership
Easier to raise money
Fewer restrictions on profit sharing
Surplus earnings not taxed

Disadvantages:
Subject to self-employment tax
Leaving members can dissolve LLC in some states

Cooperative

Structure:
Coop’s are entities operated by those they service
Members purchase shares to gain voting rights
Profits are distributed among members

Setting one up:
1) File articles of incorporation
2.) Create bylaws
3.) Create a membership application
4.) Create Charter Member Meeting and Elect Leaders
5.) Obtain Licenses and Permits

Taxes:
Operates as a corporation but “passes through” income to members
Individual members pay personal taxes on cooperative gains
Some Coop’s like Credit Unions or Rural Utility Coop’s are tax exempt

Forms:
Personal tax forms
1099-PATR
3491 Consumer Cooperative Exemption Application

Advantages:
Surplus earnings not taxed
Many government-sponsored grant opportunities
Perpetual existence
Democratic in nature
Disadvantages:
One-member one-vote often stops large investors
Reliant on members

C Corporation

Structure:
A separate legal entity owned by shareholders
Corporation shields owners from legal and monetary liability

Setting one up:
1.) Choose a name
2.) File articles of incorporation
3.) Hire a director and issue stock (in some states)
4.) Obtain business licenses and permits

Taxes:
Corporations are required to pay federal, state, and sometimes local taxes
Profit is subject to income tax
–>leading to double taxation at times
First when the corporation makes a profit
And twice when dividends are paid to shareholders

Corporations pay half of employee social security and medicare taxes
Forms:
1120
or 1120-A

Advantages:

Limited liability
Ability to generate capital
Corporate taxes often lower than personal taxes

Disadvantages:
Time and money, are spent on start-up and administrative costs
Double taxing, in some cases
Additional Paperwork
Less control for individuals

S Corporation

Structure:
S Corporations allow profits and losses to be passed through to personal tax returns
Avoiding double taxation
Only shareholders are taxed when dividends are paid.

Setting one up:
1.) File as a C Corporation
2.) Qualify for S Corporation Status
3.) All shareholders must file an IRS form 2553

Taxes:
Owners treat taxes as they would for a partnership or sole proprietorship.
Shareholders are taxed when dividends are paid.
Remaining income paid to owner as “distribution,” which is taxed at a lower rate.

Advantages:
Limited Liability
Tax savings
Shareholders separate from company.

Disadvantages:

Stricter operational processes
Shareholder Compensation requirements
Foreign ownership of shares is prohibited
More than 100 shareholders is not permitted

How-Business-Structure-Affects-TaxesThumb

Citations: