Entity Decisions Impact Your Small Business Taxes

Posted on March 8, 2016

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How Small Business Taxes Differ Between a Sole Proprietorship, Partnership and Corporation

small business taxesIf you’re considering launching a new business, or you have already gotten started, keep in mind that one of the most important decisions you’ll make is the designation of your entity type. Deciding whether you operate as a sole proprietorship or a corporation, for instance, makes a significant difference in your small business taxes. It’s critical to understand the various costs and benefits between types of entities so that you begin your business to your best advantage.

Here are the basics about various entity types and their overall impact on your small business taxes:

Sole Proprietorship: A sole proprietorship is the simplest way to get your own business started. It doesn’t require you to go through any legal proceedings to establish your business, and you can include your business’s earnings and expenses on your own income tax return. Generally, you’ll pay self-employment taxes on your earnings, so be prepared to set aside a portion of your income to prepare for filing your tax return.

An important consideration to note about starting a sole proprietorship is the issue of liability. The owner of a sole proprietorship assumes all the risk and is responsible for any debt or damages connected to the running of the business.

General Partnership: A general partnership operates similarly to a sole proprietorship, except that the ownership of the company is shared by two or more parties. You’ll each report your share of the earnings on your own tax returns, with the income levels based on your partnership agreement detailing how income will be split.

Limited Partnership: A limited partnership is similar to a general partnership, but limited partners do not pay a self-employment tax because they are not involved in the daily running of the business.

Corporations: If you are initiating a start-up that you hope will go public in the future, you may want to set it up as a corporation. However, small business taxes are not as easy on corporations as they are on other types of businesses. A regular corporation is subject to what is referred to as “double taxation” because corporations are taxed at the regular corporation tax rate, and then income paid to shareholders as income is also taxed at the taxpayer’s personal tax rate.

One way to avoid the double taxation problem is to set your business up as an S Corporation. With an S corporation, your income passes through to your personal tax return and there is no reason to file a corporate tax return. There are certain requirements for filing as an S corporation, so talk with your accountant about the option that fits your business.

Limited Liability Corporation: Running your business as an LLC has some similarities to a general partnership because taxes are generally handled on the partners’ income tax returns. However, there are some rules for qualifying as an LLC, and it doesn’t always benefit your company on your small business taxes.

Choosing your type of entity is an important decision, with many implications for taxes and liability. Consult the expertise of Bert Doerhoff, CPA and the team at AccuBiz. AccuBiz regularly works with new businesses, guiding them through the decisions that impact their profitability now and in the future.

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Posted in: Small Business