The Most Commonly Used Business Structures and Their Taxes
If you are an entrepreneur, you probably already have an idea of what business structure you should choose. The main reasons for forming a business are the exact reasons for creating any other legal entity. These reasons include:
Protecting the entity's assets
Avoiding personal liability
Providing flexibility in how the business is run
Reducing taxes
Your chosen business structure will not only define your business but will also affect the way you pay your taxes. Here is a comparison of the most commonly used business structures:
1. Sole Proprietorship and Its Tax Structure
A sole proprietorship is the simplest and easiest business structure to form. In most jurisdictions, all that is needed to start a sole proprietorship is a business license. Since this business structure is the simplest, its taxation is the simplest as well.
The sole proprietorship is not considered a separate entity. In this structure, the owner is liable for all the debts and profits, including taxes. That means that all the income earned by a sole proprietorship is counted as personal income. As a result, your business income will be reflected directly on your personal federal income tax return.
2. Partnership and Its Tax Structure
The second structure is a partnership. It is a structure similar to a sole proprietorship. It is a simple restructuring of the business by partners who are held personally liable for all the debts and profits.
In a partnership, taxable income depends on the percentage of the partnership owned by each individual. For example, if you own 50% of the business, you will be taxed on 50% of the enterprise’s income.
3. Limited Liability Partnership (LLP) and Its Tax Structure
A limited liability partnership (LLP) is a type of partnership structure wherein some or all partners have limited liability. It is flexible like a partnership and also has the benefits of a company. Liability is limited to how much a partner invests in the business. The income passes to individual tax returns through the Schedule K-1, much like a partnership.
4. Limited Liability Company (LLC) and Its Tax Structure
An LLC provides owners with legal liability. If you solely own an LLC directly, it can be treated as a sole proprietorship. If not, it’s a disregarded entity. Multi-member LLCs, on the other hand, are regarded as partnerships. However, you may choose for it to be treated as a C or S corporation if you choose.
Your income in an LLC will be reported directly on your income tax return through the Schedule K-1 unless you choose for the LLC to be regarded as a C corporation.
5. Corporation and Its Tax Structure
Corporations can either be C corporations or S corporations. In the former structure, the corporation will pay entity-level taxes first, and the shareholders will pay based on the corporation’s distributions. On the other hand, shareholders in S corporations are taxed directly.
Conclusion
There are many ways you can structure your business. You can choose a sole proprietorship, a partnership, a limited liability partnership, a limited liability company, an S corporation, or a C corporation. It all depends on the kind of business you want to form and how you want your business to be taxed. Each business structure has its advantages and disadvantages. So, you will have to decide which one is right for you.
Hiring a reputable accountant service in Denver would help assure you do not miss any of your tax deadlines. Tottax is an accounting firm that can take care of your business tax filing and preparation. Call us at (303) 536-1757, and we can help you with your tax planning.
