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Tax considerations when starting a business

Choosing a business structure for your new company can seem like a daunting task. Various types of business all have different tax implications and choosing the most advantageous one could help you offset the costs of starting up and running a business. Here are the most important business types that you can choose from, and the tax considerations that come with each.

1.Sole proprietorship
In a sole proprietorship, the business and the owner are the same legal entity, and all profits must be included in the owner’s personal tax return. As a sole proprietor, you will be taxed at your own personal rate, which can be higher or lower than the corporate tax rate. Although easy to establish, a sole proprietorship can leave you legally vulnerable, as all business debts and liabilities are the owner’s responsibility.

Corporations are considered separate legal entities from the owner, being taxed at corporate income tax rates. Corporations are also subjected to double taxation when dividends are distributed to the shareholder after taxes. The main advantage of a corporation is that, as an owner, you have no personal liability for corporate debts. Financial reporting for a corporation is, however, more complex and time-consuming.

In a partnership, similarly to a sole proprietorship, the business and the owner are legally the same entity. There is no corporate income tax, and the profit share from the business is reported on the individual tax returns of each owner and taxed at their personal rates. Partners share responsibility for any debts or liabilities. Partnerships are required to file an annual information return, including their company’s income, losses, and deductions.

4.Limited liability company (LLC)
An LLC operates like a partnership, but just like in a corporation, its owners have no personal liability for company debts. Unlike a corporation, an LLC offers more flexibility and much easier taxation procedures. For federal tax purposes, LLCs are treated as partnerships, and all the income is reported on the individual tax returns of the owners, thus avoiding double taxation.

5. S corporation
An S corporation, or an S-corp, is a corporation that has filed a special election with the IRS to be a considered an LLC for tax purposes. Therefore, S-corporations are not subjected to corporate tax, and the income is passed to the owners and reported on their tax returns. S corporations are not subjected to double taxation. An S corporation cannot have more than 100 shareholders and must contain only one type of stock. Some types of business are ineligible to claim subchapter S status.

The type of structure you chose for your business, whether is a corporation, sole proprietorship or LLC, will have important tax consequences. When you are choosing a business type, weigh carefully the tax implications against other issues, such as which type of business will better help you better operate and grow. When ready to launch your company, it is a good idea to consult a tax specialist who can advise you on the best practices for building your business.