02 Jul How Does Your Business’s Structure Impact Your Taxes?
If you’re starting a new business, one of the first things you must do is to select a business structure. For those making their first foray into entrepreneurship, it’s important that you take the time to consider all of the ways in which the various business structures impact your company’s growth and finances. The impact of your business designation on your company taxes is just one of the things you’ll want to consider before selecting which designation is right for you. Here is a quick look at how your business’s structure will impact your company’s taxes.
Why Does Your Structure Matter?
For those that are new to the business world, you might think that a business is a business, but there are many different designations for companies to choose from, and each means something a little bit different for your business. While this article will only explore the impact on your business taxes, please be aware that the designation you select impacts other aspects of your company as well, including its ability to grow and earn money, and who is considered liable in the event of a lawsuit.
If you’ve already registered your business under a certain structure, you may be able to change it. However, there can be consequences for converting to a new designation. If you want to explore your options in greater depth, please schedule an appointment with our business accountants in Provo.
There are many different types of corporations, but the most common ones are C corps and non-profits. The IRS recognizes corporations as a separate tax-paying entity, which means that the business itself is taxed on profits, can take certain business deductions, and so on.
From an accounting perspective, most types of corporations will be taxed twice; the corporate entity will be taxed when it makes a profit, and then the shareholders will be taxed when they receive their dividends from the business. Corporations also require very detailed record-keeping and reports, so if you choose this business designation, you will want to work with professional business bookkeepers to ensure everything is as detailed and accurate as possible.
While non-profits also fall under the category of corporations as far as business structure is concerned, they are taxed very differently. If you’re establishing a non-profit, you can register with the IRS to receive a tax-exempt status. However, you’ll have to meet and follow very strict requirements in regards to how you use your profits, if you hope to maintain that status.
Sole proprietorships are a fairly common business designation for first-time business owners. They’re easy to set up, and allow you to test out a business idea prior to making a more formal business structure. They also make the tax side of things a lot simpler, because you typically report your business’s profits and losses on your personal income tax return. All you need to do is file a Schedule C (Profit or Loss from a Business) and a Form 1040 along with your tax return, and you’re done.
There are two common types of partnerships: limited partnerships (LPs) and limited liability partnerships (LLPs). The main differences between these two structures is in how liability is handled. From a tax standpoint, they are largely the same.
Businesses like these operate on a pass-through taxation basis. So, in a partnership, the company’s profits and losses are passed on to the partners. Each partner receives a K-1 showing the amount to be reported on their returns; the partner then reports their share of the company’s income (or loss) using a Schedule E on their personal return. This reported income is then subject to income tax and self-employment tax.
There is a slight difference for individuals who are considered “limited partners” in the partnership, however. A limited partner would report his or her share as passive income or passive loss. Passive income is not subjected to the self-employment tax. However, passive losses from the business may be limited and only used to offset other passive income.
Limited Liability Companies
Like a partnership, a limited liability company (LLC) operates on a pass-through taxation basis. However, because LLCs can have either a single owner or multiple partners, they can be taxed in different ways.
For a single-member LLC, income is taxed in the same way as a sole proprietorship; your business’s income is reported using a Schedule C and Form 1040, and filed alongside your personal tax return. For multiple-member LLCs, the profits and losses are passed onto the partners, who receive a Schedule K-1 to file with their personal returns.
As we mentioned earlier, there are many other considerations when selecting your business’s structure. However, it’s important that you do consider the tax implications of your choice, alongside other factors. If you would like to learn more about how your business’s designation can impact your taxes, schedule an appointment with one of our business accountants in Provo.