How Your Business Structure Affects Your Taxes

Taxes are a part of life no matter who you are or what you do. When you work for an employer, you typically pay taxes through deductions from your paycheck. These are taken out by your employer and are filed with the Internal Revenue Service (IRS). When you work for yourself as a sole proprietor or the owner of a company, you are now responsible for deducting and filing these taxes; however, your business structure can determine how much you pay in business taxes, where the money comes from and your legal liability for tax debts. If you’re thinking of going into business for yourself, below are some considerations regarding business taxes:

Business Taxes As A Sole Proprietor

If you work for yourself and you don’t employ anyone, you will likely file your business taxes as a sole proprietor. This means that you are legally recognized as someone conducting business, but your services do not qualify as a corporation or partnership. For example, if you start a local handyman service and you provide general home improvement and repair services around your town, you will typically be considered a sole proprietor.

In terms of business taxes, you will file your earnings on your personal income tax forms. In this case, your personal finances as well as your business finances are considered one and the same. Your state may also have different regulations and requirements when it comes to sole proprietorships and business taxes, but on the federal level, your earnings would be filed as personal income. In most cases, this would be done through form 1040, Schedule C. Contractors who work with business entities may also receive form 1099-MISC which will list payments made for contracted services.

Business Taxes As An LLC

A limited liability corporation (LLC) is a type of business structure in which your personal assets are kept separate from your business’ finances, even if you are the only person working for the business. If someone sues the business, they are not suing the owner personally. Instead, they are suing the business entity in most cases. This provides the advantage of separating you personally from your business for legal liability purposes, but an LLC also offers business tax advantages as well. An LLC is what is referred to as a pass-through entity.

This means that a business owner of an LLC reports income and losses on their personal income tax forms instead of paying federal income tax like with a sole proprietorship. This avoids double taxation since a business would normally pay taxes on business income as well as personal taxes on income that is provided as a dividend from the business when the owner pays themselves. An LLC bypasses double taxation by allowing the owner to pass the income through the business without the money being taxed twice.

Business Taxes As A Corporation

When you form a corporation, the business entity pays taxes on its profits. This differs from an LLC, and forming a corporation is often best reserved for business owners who are making substantial investments in the business through profits and who are planning on expanding. Forming a corporation protects business entities in a number of ways, and it also offers protection for employees and business partners.

Corporations usually need to file form 1120 with the IRS. Taxes are paid quarterly, but corporations have a great number of things that can be written off as business expenses. Tax rates may be flat, meaning they may be lower than personal income tax rates; however, tax rate changes happen from time to time. Some are set to expire within a few years of being enacted while others can change from year to year.

Talk To A Tax Professional

No matter how you decide to structure your business, it’s a good idea to talk with a tax professional in your area. While different business structures typically yield similar outcomes in terms of tax liability, your situation is unique. A tax professional like a certified public accountant (CPA) can help you decide on the best strategy for your business and your personal finances.

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