If you’re starting a business, you want to do it right. One of the first things that you have to consider is the type of structure for your business (i.e. whether you’ll form an LLC, limited partnership, sole proprietorship, or corporation). The type of structure will determine which tax implications apply to your company, as well as how much paperwork is required from you.
You may also need additional licenses or business formation services, depending on the type of structure you choose for your company. In this guide, you’ll learn some of the important things about business structure and tax implications.
What Is Business Structure?
Business structure refers to the way your business is organized. It defines who owns the company and how those owners share in any profits or losses. Your business structure will also determine what tax obligations you have, as well as your liability if something goes wrong.
Business structures can be divided into two main categories: sole proprietorship and corporation. A sole proprietorship doesn’t separate ownership from the management; all owners are responsible for running their businesses. Corporations have a separation of control over ownership and management.
In addition, corporations can raise money through stock sales. In contrast, sole proprietorships cannot issue stock shares in exchange for money or assets that aren’t owned by shareholders alone. This means that if a sole proprietor needs more funds than they have on hand to start up or operate their business, they must rely solely on personal assets such as savings accounts or credit cards instead of selling company stock shares like corporate entities can do when seeking outside investment capital.
There are four main business structures, and you can select the one that best suits your requirements. The four main business structures are sole proprietorship, Partnership (LLP), Limited Liability Company (LLC), and Corporation.
The sole proprietorship is a business that one person owns. The proprietor maintains complete control over all aspects of the company and can do whatever they want with it.
Regarding tax implications, sole proprietorships are treated as ‘pass-through’ entities, so they are not required to pay taxes separately. Instead, they’re taxed on their owner’s income statement. This means that any losses incurred by the business aren’t deductible from your income taxes unless you’re self-employed, in which case you may be able to deduct those losses against your wages if they exceed two percent of your adjusted gross income (AGI).
Otherwise, if you have a loss from your business, it’ll simply show up on your tax return and reduce the amount of income taxable for the year; not an ideal situation but better than nothing.
Moreso, since individual taxpayers are required to report all income from every source each year, tracking your expenses can be very challenging unless there’s some accounting system in place at either end. The one thing that would help immensely is getting clear about which expenses belong where.
In a partnership, the partners are personally liable for all partnership debts. For example, if your business partner or employee steals from you and you don’t have money to pay off their debt anymore, then they can come after you for the amount owed to them.
In addition to this liability, partners can be held personally liable for any actions other partners take against the business. The best way to protect yourself against these risks is by having a written contract between all parties involved. This way, there will be no misunderstandings about who owns what part of the company and how much risk each party is willing to take.
In partnership, there are three main categories: general partnership, limited partnership, and limited liability partnership.
A general principle is that income from partnerships has been taxed at both levels: first at the entity level (business) and again at a personal level (owner). This means that when filing taxes as an owner, it’s essential not only to make sure that they report their income correctly but also to ensure that proper deductions have been taken into account beforehand.
Limited Liability Company (LLC)
An LLC is a compounded entity, meaning it has characteristics of both a corporation and a partnership. It’s a pass-through entity, meaning it doesn’t pay its own income taxes but instead passes all profits or losses through to the owner’s tax return. This means that you don’t need to pay separate corporate taxes for the LLC; your business will be taxed as part of your tax return.
An LLC incorporates the pass-through taxation of affiliation or sole tradership with the limited liability of a corporation. This means that when you form an LLC, you get all of the benefits associated with being able to deduct any losses from your taxes as well as being protected from any potential lawsuits against your company by creditors (but not necessarily other businesses).
When you start your business, you’ll have to decide whether to organize it as a corporation. A corporation is a separate legal entity taxed differently from other business structures. It can also make your company more attractive to potential investors and lenders, which can help you raise funds for expansion.
Corporations are taxed on their net income after deductions and exemptions but before paying any dividends or distributions. They may also be subject to special taxes based on their industry or other factors (for example, banks are subject to reserve requirements). There are two types of corporations: S corporation and C corporation.
An S corporation is a sub-type of the corporation. It’s taxed under the same rules as a C corporation (a company whose shares are held by shareholders, who then pay taxes on their income). Some tax advisors suggest S corporations are more appropriate for smaller businesses with fewer than 100 shareholders.
C Corporations are taxed separately from their owners. That means the corporation pays income (and can deduct legitimate business expenses), and then shareholders must pay taxes on dividends from the company’s profits.
C corporations can retain earnings and reinvest them into the company, which allows them to grow faster than sole proprietorships or partnerships. They also have access to more capital since investors may be more willing to invest in an entity with limited liability protection.
Tax Implications Related to Business Structure
Tax implications related to the business structure are often the most critical factor when choosing a business structure. The difference between an LLC and a corporation for tax purposes can be significant, depending on your situation.
Also, it’s essential to understand what type of business structure you have so that you know how your business will be taxed. While it may seem like a choice, there are strict rules about which businesses can operate within each type of structure.
There are many different types of businesses, and their tax implications vary depending on their structure. If you’re looking to start a new business or change the structure of an existing one, you need to understand the different types to make informed decisions about which one will work best for your situation.