Most small business owners begin as sole proprietors, partners, LLC members or corporate shareholders. How you structure your business will determine how you file your taxes. Here’s a basic outline.
Filing as a Sole Proprietor
The IRS does not consider this a separate entity. Instead, you must file a Schedule C with your individual tax return. You will net all profits and expenses and transfer that number to line 12 on your 1040 form. You must also include Schedule SE to report Social Security and Medicare tax. Here are the advantages:
- Simple and cost-effective: Owners have few startup costs aside from applicable permits.
- Autonomy: You’re in the driver seat and have complete control over operations, finance taxes and strategy.
- Easy tax preparation: Your business is not a distinct entity, and everything is included with your own 1040.
- More tax savings: Rates are lower than those of any other business entity. Here are the disadvantages:
- Liability: You are personally responsible for all debts, profits and employee-related issues.
- Pressure: If your business tanks, you have to clean up the mess.
- Difficult to fund: Most investors are interested in equity, so you’ll have a hard time securing non-bank financing.
Filing as a Partnership
A partnership is a pass-through entity that is not separate for tax purposes. Owners share all profits and report business income on their individual returns. Advantages include the following:
- Minimal startup costs: Most of your effort will go into your initial partnership agreement.
- Shared liability: Business debt is allocated, so no one member is taking on too much.
- More ideas: Each partner is involved in company decisions, thus you’re able to utilize the unique talents of each manager.
- Hiring incentives: Aggressive candidates are drawn to the idea of becoming partners. Here are the disadvantages:
- Liability: Each partner is liable for debt and the decisions of other owners.
- Shared profits: The more partners you have, the lower each share will be.
- Tax hassles: You must file informational tax forms even though the business does not pay income tax. This includes form 1065 and Schedule K-1.
Filing as an LLC
As an LLC, your company will file under a sole proprietorship, partnership or corporate tax structure. You make the election using 1120, unless you only have one owner, in which case you can’t change your default. These are the key advantages:
- Limited liability: Your personal assets will likely be spared if your business tanks or becomes involved in a legal dispute.
- Easy to establish: Startup costs are reasonable and paperwork is minimal.
- You choose your distributions: An LLC can distribute profits based on the work level or initial investment of each member. Disadvantages include the following:
- Limited growth: Members commonly leave LLCs for other ventures. Many LLCs don’t grow until they incorporate.
- Self-employment tax: LLCs do not withhold federal taxes from members. Therefore, each member is responsible for both halves of Social Security and Medicare.
Filing as a Corporation
For tax purposes, a corporation is an individual entity, and shareholders are not responsible for reporting company income and expenses on their individual tax returns. These are the primary advantages:
- Limited liability: Shareholders are only accountable for their individual investments.
- Better position for funding: This may be the only way to attract the investment profile you need to expand.
- Hiring incentives: Professionals enjoy the security, stability and benefits that come from working for a corporation. Stock options are an added bonus. Disadvantages include the following:
- Double taxation: Business income is taxed on your corporate return before you distribute dividends. Shareholders must pay the second tax when they report the extra income on their personal returns.
- Higher startup costs: Registering a corporation is more expensive than registering a partnerships or LLC. Moreover, an Initial Public Offering can be a complicated ordeal. Talk to a lawyer or accountant, especially if you’re looking to incorporate. The IRS website is also a great source for tax-related information.
The content on our website is only meant to provide general information and is not legal advice. We make our best efforts to make sure the information is accurate, but we cannot guarantee it. Do not rely on the content as legal advice. For assistance with legal problems or for a legal inquiry please contact you attorney.