Does your business structure affect how you pay taxes? The short answer is, yes, it does. Your business structure determines both how you pay and how much. Different business structures involve different tax structures. James C. Provenza is a Chicago area attorney that advises clients on business structures and how to set them up and will be a valued continual resource for your business, non profit organization, and even your family. His goal is to help you achieve your goals.
There are four basic business structures, each with its own benefits and liabilities. Ultimately, it’s up to you to choose the best one for your individual business needs.
This is the simplest option for anyone just getting started. A sole proprietorship is something called a “pass-through,” meaning that the individual is responsible for everything, including taxes.
The IRS defines a sole proprietor as “someone who owns an unincorporated business by himself or herself.” It’s very simple, and the business and the individual are one and the same.
The flip side is that the sole proprietor is responsible for all the businesses, liabilities, debts, and losses. Creditors or lawsuit claimants can have access to both the business owners’ personal accounts and assets if the business can’t cover its obligations.
Independent consultants, such as tutors, caterers, and freelancers commonly use this structure. Taxwise, a sole proprietor reports business revenues, and expenses on Schedule C, which is attached to a Form 1040. The proprietor is taxed on all profits for the year, even if some of the money is kept in the business bank account for future expenses.
The sole proprietor also is required to pay self-employment taxes, meaning that you are solely responsible for Medicare and Social Security contributions. That tax rate is 15.3%, most of which goes towards Social Security.
A sole proprietorship is ideal for people who want to keep things simple. It costs nothing to start. People who use sole proprietorships aren’t concerned about liability and being separate from their business. They’re not making a significant profit every year. It’s also suitable for someone who is just starting out and testing the waters of entrepreneurship.
For those who have a partner to start their business with, a partnership is a more suitable option. They are also easy to create, and there are three types of partnerships to choose from:
1. General partnership. Two or more partners share all responsibility and liability. The partners handle daily operations and are all equally liable for any debts from the business. All partners are considered “general partners.”
2. Limited partnership. There is both a general partner and a limited partner. The general partner assumes ownership of the business operations and carries unlimited liability. A limited partner also called a “silent partner,” is a capital investor. The silent partner is not involved in the operations and has no voting rights. Therefore, he or she has limited liability.
3. Limited liability partnership, or LLP. All partners carry limited personal liability and are not liable for acts of malpractice or negligence committed by another partner. All partners are involved in daily operations. The partners can determine their own management structure, so there is more flexibility.
Partnerships are also considered a pass-through entity for tax purposes. A partnership is similar to a sole proprietorship but has both advantages and disadvantages. It’s important to know exactly who you’re going into business with because a partner can affect the business either positively or negatively. Still, a partner can bring needed capital, skills, and expertise to the business.
Limited Liability Company, or LLC
An LLC is a hybrid between a sole proprietorship and a partnership. Its regulations fall under state law, and the regulations vary by state. The IRS will treat an LLC as a corporation, partnership, or as part of the owner’s tax return, depending on how the LLC is structured.
Everything depends on the elections made by the owners of the LLC. This offers more flexibility and protection than other business structures. The members of an LLC don’t carry the personal liability of a sole proprietorship or partnership. It is also flexible when it comes to federal tax because it’s an entity created by a state statute.
The LLC may be a sole proprietorship or a C corporation with a federal tax filing and payment due date of April 15th every year.
But an LLC taxed as an S corporation or partnership generally has a federal tax filing due date of March 15th and a payment deadline that correlates to the individual tax return.
Incorporating brings a new level of business structure. Once incorporated, a company is considered separate and distinct from its owners, meaning that there is no personal liability as there is with the previous structures.
A corporation is also a legal entity and receives many rights that people have. This means that the corporation can sue or be sued, enter into a contract, and is even entitled to free speech. Corporations are the only business tax structure that is created for perpetual existence. This means the company’s continuance won’t be affected by the presence or absence of shareholders, officers, and directors.
The IRS recognizes two types of corporations:
• C Corporation. This type is not a pass-through entity and means that they are taxed twice—at a corporate and a personal income level, known as “double taxation.” C Corporation is the default designation for corporations, and all corporations start as a C corporation when filing articles of incorporation with the states’ regulating agency.
• S Corporation. This is a structure that is a pass-through entity, which allows it to avoid double taxation. However, the IRS has very strict standards for companies that want to qualify as an S corporation, particularly with shareholders. An S Corporation can only have 100 shareholders, and they are required to be U.S. citizens or residents. Additionally, the S Corporation must always file its annual tax return by the 15th day of the third month following the end of the year, which is usually March 15th. The income is then passed to its members individually, who are then required to file by April Tax Day.
Because of the complexity of the various business structures, and the tax and legal implications, it’s best to consult with an attorney who understands the structures and can help you decide which is best for your individual situation.
Contact James C. Provenza & Associates, PC For Advice on Your Business Structure
Located in beautiful Glenview, Illinois, the office of James C. Provenza & Associates, PC is available for visits Monday through Friday during normal business hours. We serve Chicago, Deerfield, and Oakbrook, as well as many other areas throughout the area. Call us today at (847) 729-3939 or use our online contact form to make an appointment. You can also sign up for our blog and stay up-to-date on legal issues that concern you.