Owning your own business means that you make all the major decisions, including the ones that can have a real impact on your taxes. One of the earliest and most importantdecisionsyou’llmakeistochoose the legal form your business should adopt. The most common forms are a sole proprietorship, a partnership, or a corporation. Each has different tax consequences and making the right choice can have a very positive effect on your tax picture. Sole Proprietorships A sole proprietor is an unincorporated business that has only one owner. It is a simple legal entity in which you are your own master. A sole proprietorship hasthree major tax advantages: You candeduct any losses you incur from your business start up costs on your personal income tax return. These start up costs can be used to reduce your taxable income from othersources. You avoid double taxation. Income generated from a regular corporation is taxed twice. First, your business pays a corporate income tax on its profits. And then, as a shareholder, you pay personal income taxes on any dividends you receive from the corporation. On the other hand, income from a sole proprietorship is taxed only once - as income on your personal income tax return. Your overalltax burden may be less depending upon the tax bracket you are in. Partnerships A partnership is similar to a sole proprietorship with the exception that it has more than one owner. Eachpartner’s share of income, loss, and deductionsisset forth in the partnership agreement. As in a sole proprietorship, these items are reflected on each partner’s personal income tax return. Partnerships have additional tax advantages: Income is taxed at each individual partner’s personal income tax rate. You avoid double taxation because a partnership does not pay taxes. As a partner, you can deduct business losses to the extent that you are liable for obligations of the partnership. You can allocate losses differently than profits. If you provide most of the start up costs, you can take a larger share of the losses, even ifthe profits are shared equally by the partners. And the way you allocate profit and loss to each partner can be changed from year to year to accommodate changes in your personal circumstances. “S” Corporations An “S” corporation is a business that is formed under the rules of Subchapter S of the Tax Code. Operating your business as an “S” corporation hasseveral tax advantages: You may pay less taxes, depending upon the tax bracket you are in. You avoid double taxation. Your businessprofitsaretaxedonlyonce, directly to you as a shareholder, on your personal income tax return. • • • • • You avoid tax penalties on excess accumulated earnings. Since “S” corporation profits are taxed to stockholders even if they don’t receive them, you can’t be penalized for accumulated excess earnings in the business as can a regular corporation. You don’t pay double taxes when your“S” corporation is liquidated. If a regular corporation is liquidated, the corporation istaxedon the gain and you and other shareholders are taxed on the portion ofthe gain which you receive. Since there are no corporate income taxes for an “S” corporation, you avoid double taxation when an“S” corporation is liquidated. Regular “C” Corporations Regular“C” corporations are a unique form of business. They are subject to a special tax structure and their earnings can be taxed twice, first at the corporate level and again when they are distributed to stockholders as dividends. The double tax can be avoided by retaining earnings in the corporation rather than distributing them as dividends. This must be carefully planned, however, since the IRS can penalize a corporation for excessive accumulation of earnings. The penalty can be avoided only if a corporation can demonstrate that it has good business reasons for accumulating earnings. Even if you own a small business, you can gain certain tax advantages from incorporating. For example, corporate tax rates on the first $75,000 of income are often lower than personal income tax rates. • • Here’s how corporate income is taxed: CORPORATE INCOME TAX RATE $0 - $50,000 15% $50,000 - $75,000 25% $75,000 - $100,000 34% $100,000 - $335,000 39% $335,000 - $10,000,000 34% $10,000,000 - $15,000,000 35% $15,000,000 - $18,333,333 38% over $18,333,333 35% Your choice of a legal form for your business can have far-reaching consequences on your income taxes. It’s best to consult your accountant before you make that important decision
