There are many advantages to having your own business. You can decide how many working hours to schedule for each week, the brand of coffee used in the office, and the brand of air freshener. Regardless of how much fun you are having with your business taking the bull by the horns, having to do taxes makes every business owner tremble. Nobody wants to spend the weekend calculating taxes.
The government divides the annual tax payments into four quarterly payments, for the convenience of businesses. Some business owners prefer to use a business tax calculator instead of manually calculating taxes. It is still important to understand the basic ideas and principles to calculate business tax even if you are using a tax calculator. Here we look at all the different factors that affect how taxes are calculated for a business.
What Is Your Business Legal Structure?
Every business owner must specify a business structure before they can register themselves with the state. You need to designate a business structure before you can start your beauty salon, 24/7 shop, or cafeteria. According to the IRS, there are seven different types of business structures in the United States.
- Sole Proprietorship
- Limited Liability Company (LLC)
- Corporation (C-Corp)
- Corporation (S-Corp)
- Corporation (B-Corp)
- Corporation (Nonprofit)
The government has specific rules and regulations of a business based on the business structure.
A sole proprietorship is a business owned and operated by a single person. It is unincorporated which means all the business decisions are made by a single person. The owner is responsible for all business loans, profits, and liabilities. A sole proprietorship needs to obtain federal and state licenses to operate in a specific business specialization.
A sole proprietorship is not registered with the state. The owner is fully responsible for any debts incurred by the business. Other businesses can take legal action if the owner fails to pay off loans. However, the owner is fully redeemed with all the profit for the organization.
The owner must pay taxes using a 1040 Form on all income listed. This includes income from business activity. Owners should maintain personal and business accounts separately specifically for tax purposes. The owner pays property tax on any properties owned by the business.
You are in a partnership if you have signed a partnership agreement with one or more investors. The two types of partners in a partnership are general partners and limited partners. A general partner plays an active role in the decision-making and functioning of the business. Limited partners are investors that do not have anything to do with the daily functioning of the business.
A partnership uses a Form 1065 to file taxes on the overall partnership. A partnership is a “pass-through” entity. This means that any business income from the partnership is considered as the owner’s income for tax purposes.
Limited Liability Company (LLC)
A limited liability company has two or more partners that share a limited liability to allow flexibility in business management. The structure allows the profits and losses to pass through to the owners similar to a partnership. The LLC is formed by filing a document also known as an Articles of Organization. Each owner of the LLC is known as a member.
An LLC is taxed either as a partnership or a sole proprietorship depending on the number of members. In both cases, the members are taxed individually. The LLC is not taxed as an entity. This means that the income will pass-through individually to each member.
A corporation or C-corp is a legal organization that is treated separately from its owners. This business structure is more expensive to form than the above business structures. But it provides higher protection from personal liability to its owners. The record-keeping requirements for corporations are extensive.
A corporation can continue to function without any difficulty if a new shareholder enters the corporation or sells its shares to leave it.
Members of a C-corp are sometimes taxed twice. Initially, the company’s earnings are taxed when it makes a profit. It is taxed again when the profit is divided amongst the dividends. A C-corp must file Form 1120 each year based on the annual profit amounts. The tax rate can be anywhere between 15% to 39%.
An S-corp is a corporation or limited liability company with special tax-exempt privileges. It is a pass-through entity but still considered a corporation. The personal assets of an S-corporation have legal protection different from those of a business. For example, investors are not individually liable for the loan of the corporation.
An S-corp only allows for one type of stock. They must pay their taxes by the end of the fiscal year, which is December 31. The IRS might be tracking the activities of S-corp owners so that they don’t avoid paying taxes.
An S-corp must file taxes using Form 1120S. One of the biggest advantages for S-corps owners is that they do not need to file self-employment tax. Each shareholder must be getting a reasonable fixed income as a monthly salary.
A B-Corporation is also known as a benefit corporation. This is one of the newer forms of business structure. A B-corp needs to have the stamp of approval or certification from a third-party certifying authority or a B-Lab. A B-corp needs to meet rigorous requirements of environmental and social functioning including transparency and accountability.
A B-corp must pay taxes just like a C-corp. In some cases, the B-corp will be taxed twice. The first time on a corporate level and the second time on an individual level for each investor.
A nonprofit corporation is set up for education, charity, religious, scientific, or literary purposes. Their business activity benefits the general public. A nonprofit corporation must register itself with the IRS to receive tax exemptions. Registering with the IRS is different from registering with their state.
After a nonprofit corporation registers with the IRS it will be treated like a C-corp with tax-exempt status. A nonprofit corporation cannot accumulate profits to share with its investors. A nonprofit corporation is sometimes also known as a 501(C)(3) corporation.