Clients are often concerned with how to deal with their business taxes. This area contains a great deal of nuance, and we will focus on the four most common tax structures utilized by business owners.
What do you need to know about business taxes?
If you are the sole owner of a business and you have not created an LLC, you are known as a sole proprietor. If you have created an LLC where you are the only member, this is called a single member LLC. For tax purposes, they are treated exactly the same. Both business structures are reported on Schedule C as part of an individual taxpayer’s income tax return. In other words, there is no separate tax return required for the business. The only requirement is Schedule C, which is an attachment to the individual income tax return. The individual income tax return is due April 15 on an annual basis.
This type of structure subjects the owner to Federal self-employment tax, which is an additional 15.3% on business income up to a certain limit. Since you are the owner of a business, the IRS expects you to pay payroll taxes for both the employer and the employee. This is typically an undesirable business structure for taxpayers. (If you are a sole proprietor and have not yet created an LLC, please consult with an attorney. LLCs provide important legal protections.)
When a business is owned by more than one person, the business is taxed as a partnership by default by the IRS. A partnership is different from a single member LLC in that it requires its own tax filing, otherwise known as Form 1065. This tax filing (generally speaking) is informational only. Its purpose is to report the income and expenses of the partnership, and let the partners know their share of these items. The due date for Form 1065 is March 15 on an annual basis. Taxpayers may extend the amount of time to file the tax return to September 15.
Once the partnership tax returns are complete, the partners then report their portion of income and expense (taken from Schedule K-1 which is produced with Form 1065) on their individual income tax returns and pay tax on that income. Hence, the partnership income is reported along with the other income of the partner on the individual tax return.
An important item to note is that active partners in a partnership are still subject to self-employment tax. Many small business owners consider the next structure as an excellent way of reducing self-employment taxes.
The S-Corporation is unique tax structure in that it can be utilized by a single member LLC (a single business owner) or in lieu of a partnership or C corporation (multiple owners). An S-Corporation also requires its own tax filing using Form 1120S. Income earned by an S-Corporation is -not- subject to self-employment tax. However, there are caveats that come along with this. Although an S-Corporation can provide access to significant tax savings, it also means that your professional fees will increase. Established businesses with healthy revenue are typically excellent candidates for S-Corporation status. Many sole proprietors choose to be treated as S-Corporations to access the additional tax savings. S-Corporation tax returns (Form 1120S) are due on March 15 each year.
The C-Corporation is a tax structure typically utilized by larger establishments. This type of structure consists of many shareholders each owning a percentage of the corporation. These are the companies you see everyday, such as Apple, Microsoft, or Tesla. C-Corporations are subject to “double taxation” since the income is taxed a the corporate level and taxed at the individual level when dividends are distributed. This is not typically a tax structure utilized by small businesses. C-Corporation tax returns (Form 1120) are due on April 15 annually.
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