Whether or not you have been in business for 20 years or you have just formed a business, you may benefit from reviewing the various forms of business to make sure that your current structure meets your needs from both a non-tax and tax point of view. There are several forms of businesses, and each of them have different tax implications. They are as follows:
Corporations and S Corporations
• Taxable Income
When determining income taxes due on its taxable income, corporations (excluding S corporations) use the following schedule:
• Dividends Paid to Shareholders
When corporate income is distributed to shareholders as dividends, the corporation receives no deductions for the payments, and the income is taxed again to the shareholders, although this comes with some advantages:
• Individual shareholders have a relatively low tax rate (at most 20%) on qualified dividends
• A corporation may deduct reasonable amounts of compensation paid to shareholders employed by the company. By paying out corporate earnings in the form of tax-deductible compensation, double taxation of the earnings is avoided.
• Leasing business property or equipment to your corporation is another way to draw out corporate earnings. Your corporation deducts the rent expense, and you declare the rent as income.
Corporations may receive an “accumulated earnings penalty” if it keeps more earnings and profits necessary to meet reasonable requirements. The penalty is equal up to 20% of accumulated taxable income, and is designed to encourage corporations to pay taxable dividends to shareholders.
• Alternative Minimum Tax (AMT)
Regular corporations may be subject to the alternative minimum tax (AMT), unless they are qualified as a “small” corporation. A small corporation has average annual gross receipts for all three-year periods beginning after 1993 and ending before the current year of no more than $7.5 million.
S Corporations do not pay corporate income taxes at the federal level. The S corporation’s income, losses, deductions, and credits are passed through to its shareholders to be included on their tax returns. This avoids double taxation, as the corporate income is only taxed once to its shareholders.
Limited Liability Company (LLC)
LLCs typically have one owner or have several co-owners, known as “members”. The LLC’s income generally is taxed to the owners individually, and a Limited Liability Company has more freedom in allocating income and deductions among the owners than an S corporation.
Partnerships have more than owner and do not pay federal income taxes at the entity level, but still have to file an annual informational return with the IRS (Form 1065). The partnership agreement addresses how business profits and losses will be divided among the partners.
Sole proprietors report their business income and expenses on Schedule C, which is an attachment to the individual income tax return. Net earnings from the business are taxed directly to the owner. To minimize self-employment taxes, plan to take as many deductions as possible on Schedule C.
Determining which business type fits your current needs requires a thorough and thoughtful analysis, which is something we at Mazur & Associates can provide to you. Reach out to us to with any questions or schedule a face to face meeting at our office. Our phone number is (732) 936-1230.