Get Ready for Taxes – Choose the Right Business Structure

No matter what country in the world you work in, the taxes you have to pay depend on the type of your business. Since many new business owners don’t fully understand how their business structure affects their taxes, we’ve prepared a guide that will clarify this link. From the Limited Liability Company (LLC) to the corporation and the sole proprietorship, you’ll get a better insight into different forms of business. As a result, you’ll have more information about the best option for your particular case.

Taxation for the Limited Liability Company (LLC)

The greatest advantage of the LLC is the fact that your personal and business assets are two separated features in this type of business. This is an extremely practical option when your business is in financial dire straits and you get sued or the bank blocks your account.

If you’re the owner of an LLC, you’ll only be liable for the business-related assets. Your home, your car(s) and any other personal assets aren’t considered a part of your business assets.

Regarding the taxes, as the owner of an LLC, you’ll have to pay taxes on your part of the profit that the business makes. For example, let’s assume that you’re the only owner of an LLC and that your venture has made $50,000 during one fiscal year. If you want to leave a part of that amount – say, $15,000 on your account for some business expenses that you’ll have in the following fiscal year, you have to report the entire annual income to the IRS and they’ll charge you for that sum.

Moreover, if you don’t only own an LLC, but you work in it, as well, you’ll also require covering the taxes pertaining to the self-employment status.

Additionally, you can choose to have your LLC treated as an S-corporation by the IRS. In that case, you’ll be able to divide the income into two parts. The first one will be used as your salary and the other one will be assigned to the distributions. However, it’s important to give yourself a common salary for your niche, since your social security tax and Medicare payments are deducted from your salary. The IRS will check that sum, so don’t try to trick them by setting too low a salary and leave more money in the distributions.

The corporation business structure and taxation

A more complex and advanced form of business, the corporation, completely separates you from your business. The biggest benefit of this business structure is the fact that your personal assets are completely independent of your company assets.

For instance, if someone wants to file a legal complaint against your corporation, your private assets will stay intact, regardless of the court decision.

Also, when you and your business partners want to take a loan for the corporation, the credit bureau will check the rating of the corporation and not your personal credit history.

As for the taxes, the corporation is a taxable entity, which means that taxes are paid directly on the profits of the corporation.

However, there’s a difference between taxes for S-corporations and C-corporations. The former structure is a more viable option for business owners who want to have their income and losses forwarded to their personal income, as shareholders.

The C-corporation, on the other hand, enables business owners to retain some part of the income within the business. That way, they’re taxed only for the amount they get in the form of distributions.

Going for the C-corporation taxation system is the best solution for the business owners who are planning to expand their business in the near future. Those assets will serve as the future investment for that purpose.

However, going for either of these two business structures will result in increased paperwork.

Sole proprietorships for business loners

Some fields of work and projects don’t support teamwork or having employees. If you work in such a niche, the best choice for you is to register your business as a sole proprietorship.

On the positive side, you don’t have to bother with too many administrative works, but you can simplify the business accounting process. You need to file your entire income on your Schedule C, together with the Form 1040 for your business.

The negative aspect of this business structure, tax-wise, is the fact that your personal assets are liable for your business losses. What’s more, everything you make via your business is reported on the same tax form. When your personal income is considered your personal income, you might experience certain inconveniences your business is sued or falls in debt.

Also, as a sole proprietor, you’ll be obliged to pay the self-employment tax – read social security and Medicare.

For all these reasons, choosing the sole proprietorship business structure is the most practical solution for business individuals who aren’t planning to make too high annual profits. Moreover, it’s a suitable solution for the entrepreneurs who aren’t running high business risks. As a result, they won’t expose their personal assets to any hazardous business moves, which is a dangerous thing to do in this form of business.

Conclusion

When choosing the best type of business structure for your business is to start from the least complicated one. In line with that, individual entrepreneurs should start with a sole proprietorship. On the other hand, a group of aspiring business owners will find the best business combination in the LLC business structure. Also, more ambitious and determined pros can use the benefits of the corporate business form.

Finally, your tax preferences will also affect your choice of business structure, as well as your business plan, i.e. whether you want to invest the earned income in the future deals or pay yourself a salary. Only when you weigh the pros and cons of all these tax aspects should you go and register your business.

Mark Thomasson
Mark is a biz-dev hero at Invoicebus - a simple invoicing service that gets your invoices paid faster. He passionately blogs on topics that help small biz owners succeed in their business. He is also a lifelong learner who practices mindfulness and enjoys long walks in nature more than anything else.
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