Taxation for Businesses

One of the deciding factors of choosing a type of ownership for a business, including a sole proprietorship, partnership and corporation, is tax implications. Each type of business has its own benefits and disadvantages when it comes to taxes. Below is an overview of each type of business entity and its tax ramifications.

Corporation

A corporation is a business entity with a separate legal status. In order to understand the tax implications, it is important to differentiate regular corporations, or C corporation, from subchapter corporations, or S corporations. The main difference is that taxes are paid by the businesses in a C corporation once they have been earned and once more when shareholders receive funds. This is referred to as a double taxation.

Many businesses choose to become S corporations in order to avoid double taxation. A form 255d must be filed with the IRS and all income goes through directly to the shareholders. The downside is that S corporations can issue only one class of stock and can have up to 100 shareholders. All shareholders must also elect S status as well.

S corporations and C corporations have their own limitations when it comes to deductibles. For example, paid health insurance for the owner and his family cannot be deducted in an S corporation.

Sole Proprietorship

A sole proprietorship has one owner who reports income and other expenses when filing Form 1040. Profits and losses are combined with personal income as well. Generally speaking, sole proprietors pay the self-employment tax, which is 15.3 percent of net earnings. Half of this self-employment tax, however, is deductible.

Partnership

A partnership is a business similar to a sole proprietorship but with two or more owners. The partners are taxed on their income and all income goes directly to the partners. The owners are usually taxed whether the income is distributed to them or not. All income and expenses must be reported on Schedule E and filed with personal tax forms. Partnerships are also subject to the self-employment tax.

Limited Liability Corporation (LLC)

A limited liability corporation, or LLC, require that the profits and losses go directly to shareholders, which helps avoid double taxation. With an LLC, owners and partners are protected from liability for business debt and other actions. The main aspect of an LLC is that it allows the owner to choose the tax entity considering that it is not its own entity. In other words, owners of an LLC have the freedom to choose a sole proprietorship, partnership or corporation as the tax entity.

When choosing a type of business entity, it is important to consider taxation as part of the equation. Not every business is suitable for incorporation, but will benefit from being a proprietorship. Having a clear understanding of all the tax ramifications, business owners can make sound decisions.