By Mark Jaeger
This nothing simple starting and owning a business. The choices are everywhere -. In business plans, company names, prices, employees, benefits and office space
But first, to register your business with federal and state agencies you will need to choose a business structure, and that choice can have consequences that are not immediately clear.
structure A business is basically how it is organized. It answers questions such as who is responsible, how the profits will be distributed and if the owners are liable for the debts accumulated by the company
The most common business structures recognized IRS are as follows :.
- Individual companies , which have an owner. The owner takes home every company profits as personal income. The company and owner are the same legal entity; the owner is personally liable for business debts.
- Partnerships , which are structured as individual companies, except with an unlimited number of owners.
- C companies , which have an unlimited number of shareholders. Each shareholder owns part of the company. Profits are distributed (in dividends) between all owners-shareholders. C corporations and their owners are separate legal entities; owners are generally not personally liable for business debts.
- S corporations , which are structured as C corporations, except that the number of shareholders is limited to 100.
obviously a choice structure affects the way a business operates. Perhaps less clear, it also affects how a company and its owners pay taxes, sometimes dramatically.
The US tax code is fairly detailed, and there are countless tax ramifications to select any particular business structure. But there are some basic tax differences, we can count on to help us decide
federal business taxes are split into four main categories :.
- Income taxes , which are income taxes of business
- employment taxes , which are the contributions health insurance and social security of employees
- self-employment taxes , which are Medicare and social security contributions of individual self-employed
- excise taxes , which are special taxes applied to products or services (such as tobacco, alcohol, gambling and some vaccines)] [special
excise taxes, for one, are applied regardless of the company structure. But for the income tax and taxes employment / self-employment, how many businesses and their owners end up paying is directly related to the structure.
Most major US companies are structured as companies, which are separate legal entities from their owners. They are also separate fiscal entities. To the IRS, the corporation is a person to be taxed as any other person. In terms of tax on corporate income, this means that the benefits are often taxed twice.
Since the company is a taxable entity in itself, it pays its own income tax on profits derived. Then, when those profits are distributed to shareholders as dividends, the shareholders pay income tax through their tax returns.
This double taxation is one of the major tax disadvantages to the company's business structure.
Conversely, a company does not distribute every last penny. It is allowed to keep a portion of its profits in the business, usually (or supposedly) to cover post-filing expenses or to put toward future growth
This can be a tax advantage :. While the undistributed money is always taxed a second time, it is taxed at the tax rate on corporate income, which is often lower than the personal rate owners.
to avoid double taxation on profits and reduce the complexity of the tax return, many small businesses choose to organize as one of the pass-through tax entities
sole proprietorships, partnerships and S corporations are pass-through entities. they and their owners are the same taxable entity in the eyes of the IRS, so that the income tax is levied only once. All profits "pass through" to the company's owners, who pay taxes on that money when they file their personal income tax returns.
Pass-through entities can potentially save a lot when it comes to income tax. It is unique in relation to double taxation. easy decision, right? Not always. invoiced entities may get slammed when it comes to Medicare and Social Security.
Social Security and Medicare contributions, collectively employment taxes are calculated based on a person's income. When you work for a company as an employee, your income is the salary you take home, and you and the company split the cost of your employment taxes.
When you work for yourself, your income is your entire company's net profit, and no one will share anything.
self-employment taxes can be a huge drain. For this reason, many owners of small independent businesses choose the S corporation structure.
Essentially, S corporations combine tax benefit on income from writing off with the advantage of the employment tax to be employed by someone else.
In companies, both types C and S, owners can also be used. The company pays a salary as all other employees. And as employees, business owners pay taxes on employment than on wages, not on whole profits of their companies.
Ultimately, the structure is more beneficial depends on the specifics of the company and the minutiae corresponding US tax code
But in brief :. especially if you are looking for the tax simplicity, sole proprietorship or a company is a good bet; especially if you are looking for tax savings and have less than 100 owners, an S corporation might be the right; and finally, if you have 1000 owners, simplicity is probably not in the cards, and the S-corporation is not an option -. Company C is
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