With so many different business entities to choose from, it is very helpful to be familiar with each, as well as the benefits they provide. For instance, it is helpful to know which business entity saves on taxes. The most common business entities are sole proprietorships, partnerships, limited liability companies and corporations. The tax consequences and possible sources of liability are different, depending on the type of business entity you are dealing with.
Sole Proprietorships are not true “entities”
If you own a business alone, and do not register it as a corporation, then it will automatically be considered a sole proprietorship, unless you elect to be treated as an LLC. Nevertheless, a sole proprietorship is actually a “pass through” entity. That means, the owner pays the personal income taxes on the earnings from the business, as well as self-employment taxes. A sole proprietorship is, however, allowed to deduct business expenses on their personal income tax returns. One tax benefit of a sole proprietorship is that the owner is essentially only taxed once on business income. Also, net losses can be “carried” to other tax years, in order to offset tax liability.
Traditional Partnerships are also “pass through” entities
Much like a sole proprietorship, a partnership is the default structure of an entity with more than one owner, which has not been registered as a corporation. Again, like a sole proprietorship, capital gains and income are taxed to the business owners. This is often at a higher rate than taxes imposed on other business structures.
Partners are only taxed once and the partners can “assign” property, income and debts to other partners. Another benefit is that property disbursement taxes can be avoided with a partnership, as the assets can be transferred from the business more easily.
IRS designations of corporations
The IRS recognizes two specific types of corporations, for tax purposes: S-Corporations and C-Corporations. An S-Corporation operates much like a sole proprietorship or partnership. The income is passed through to the owners, who are taxed. Profits and losses are allocated proportionally. You can file IRS Form 2553 and elect to be taxed as a small business corporation or S-Corporation.
Limited Liability Entities
Limited Liability Companies (LLCs) and Limited Liability Partnerships (LLPs) are entities established solely by state statute. It is possible for either of these entities to elect to be taxed as “pass through” entities, such as S-Corporations or general partnerships. Many business owners choose to make this election because it allows them the ability to avoid double taxation. The flexibility of a limited liability entity allows the business owners to assign income and losses to some extent, which is helpful. While the tax consequences of a chosen business entity are significant, the type of business entity you choose must depend on many other factors, as well.
If you have questions regarding business taxes, or any other small business planning needs, please contact Sexton, Bailey Attorneys, PA online or by calling us at (470) 443-0062.