Tuesday, May 05, 2009

The Tax Consequences of Common Business Entities

Last week the RDTC Tax Help Blog posted an informative entry on the tax consequences of the 5 most common business entities in the US. Check out the text of the article below.

1. Sole Proprietors

With a sole proprietorship, there is no distinction between the person who owns the business and the business itself. Because of this, the sole proprietor is liable for any legal disputes against the business, as well as all tax liabilities. Specifically, the business owner is liable for income and self-employment taxes on all business profits. There are numerous disadvantages of sole proprietorships but one advantage is that an owner can hire their children and not have to pay payroll taxes. Sole proprietors also have the advantage of not being charged a penalty should they dissolve the business.

2. General Partnership

A general partnership is pretty similar to a sole proprietorship, however the liability is spread between multiple taxpayers, instead of just one person. While both sole proprietorships and general partnership give you more tax flexibility, it comes at the expense of also being more liable both legally and financially.

3. Limited Liability Companies (LLCs)

A great advantage of an LLC is the benefit of no double taxation. You also receive more flexible tax options. An LLC owner can choose between having the business taxed separately as its own entity, or decide to have the taxes pass down like with a partnership or sole proprietorship. This flexibility and added insurance has made LLCs a good option for many business owners in this country.

4. Corporation

If you choose to incorporate your business, the corporation will be taxed at it's own corporate tax rate. While sole proprietors see flow-through income, C-corporations, encounter “double taxation.” Meaning the corporation is taxed for the income it earns, then, the individual shareholder is also taxed on their income. However, C-corporations do get to enjoy a wide range of tax deductions for business losses and fringe benefits.

5. S-Corporation

In addition to C-corporations, the IRS also recognizes what is known as an S-Corporation. You can make the change simply by filing Form 2553 with the IRS. As opposed to C-corporations, an S-corporation is not taxed separately, but more like a partnership or sole proprietorship would be. Therefore the biggest benefit is that S-corporation owners can avoid being double taxed on their income.

Other Considerations: State Taxes

There may be specific state liabilities for some business entities, depending on where you live. These taxes can often sway you one way or the other if you are having trouble deciding. Always make sure to check out your state tax board for information on business taxes before you make any decisions.

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