Tax Treatment of Business Entities Part 1: Introduction
When starting a business enterprise, one of the most significant and important decisions to make is the choice regarding the legal form to use in operating the business. The alternatives include sole proprietorship, partnership, corporation (C corporation), S corporation, and limited liability company (LLC). Startup business owners must consider the legal and tax considerations associated with selecting a particular type of business structure. This is the first part of a series of blogs on the tax treatment of business entities.
As a business expands, it may be desirable to change its legal form to attract investors, alter capital structure, and shield increased revenue from business and tax liability. Fledgling business owners must consider and weigh the tax considerations associated with each business type.
Tax issues must be considered along with non-tax issues, such as which business form will maximize daily operations and long-term growth. There are significant income tax consequences that flow from each of these choices. There are less significant ones as well, such as the form of business determines which income tax return form must be filed.
While state law controls the formation of your business, federal tax law controls how your business is taxed. Federal tax law recognizes an additional business form, the Subchapter S Corporation. All businesses must file an annual return. The form you use depends on how your business is organized. Sole proprietorships and corporations file an income tax return. Partnerships and S Corporations, as pass-through businesses, file an information return.
For an LLC with at least two members, except for some businesses that are automatically classified as a corporation, it can choose to be classified for tax purposes as either a corporation or a partnership. A business with a single member can choose to be classified as either a corporation or disregarded as an entity separate from its owner, that is, a “disregarded entity.” As a disregarded entity, the LLC will not file a separate return, instead, all the income or loss is reported by the single member/owner on its annual return.
A sole proprietor is someone who owns an unincorporated business by himself or herself. A sole proprietorship is the most common form of business organization. It’s easy to form and offers complete control to the owner. It is any unincorporated business owned entirely by one individual.
In general, the owner is also personally liable for all financial obligations and debts of the business. (State law may also govern this area depending on the state.) It must be a business, not an investment or hobby. It can be full-time or part-time work. Your net business income or loss is combined with your other income and deductions and taxed at individual rates on your personal tax return.
Sole proprietors do not have taxes withheld from their business income so you will generally need to make quarterly estimated tax payments if you expect to make a profit. These estimated payments include both income tax and self-employment taxes for Social Security and Medicare. The next blog focuses on LLCs. Please stay tuned.
An experienced and knowledgeable tax professional may help any individual or business assess their current tax situation as it stands in the present looking ahead to the future. A tax professional may evaluate anyone’s situation to help determine the wisdom of any year-end tax savings moves. If you are an individual or business in the New York or Tri-State area and have any question about taxes, especially in planning ahead for the next filing season, call THE TAX EXPERTS at the Thorgood Law Firm www.thorgoodlaw.com. For a FREE consultation call 212-490-0704.