When setting up a business, you have a choice of what type of business entity you would like to select. Each business entity has its advantages and disadvantages. The best business
entity for you largely depends on several factors: Your personal tax situation, the income and size of the business, future plans for the business, your residency or US citizenship status. These are just a few factors that go into determining what business entity is best for you. Here are the basics on each business entity.
Sole Proprietorships
- The simplest structure of all choices.
- The owner, if he has no employees, will have no payroll, or payroll tax reports to worry about.
- The owner cannot take W2 wages.
- There is no year-end corporate tax return or partnership return to file and business Income is reported on the owner's personal tax return.
- The owner will have to pay self-employment taxes on the income earned from the sole proprietorship.
- The owner will have to track net income carefully and pay estimated quarterly taxes based on the net income of the business for that quarter. If the owner does not pay any estimated taxes or under pays during the year, there may be a penalty for under payment of income taxes. The owner may also have to write a large check.
- Total Taxes (federal, state, local and self employment taxes) from the business, can total up to 60% of the net income of the business. The amount of taxes you owe depends on your personal income tax bracket and the state income tax you are liable for.
For example
- Assume you did not pay any taxes during the year and your business generated $50,000 in income.
- The self-employment taxes would be (13.3%) $7,650;
- Federal taxes at the 15% tax bracket would be an additional $7,500;
- Assume you live in a state with a state income tax rate of 7%. The state tax is an additional $3,500.
In this example, on only $50,000 of business income the total for federal, state and self employment taxes is $18,650. This example assumes a low federal tax bracket and does not include a penalty for underpayment of taxes.
Partnerships
- Commonly used in real estate ventures and other passive income generating activities since passive income is not subject to self employment taxes.
- A Partnership, like a Sole Proprietorship, if it has no employees, will have no payroll, or payroll tax reports to worry about.
- A Partnership return is required and the income earned for each partner is reported on a K1.
- The income for each partner is based on his or her percentage of the partnership.
- Each partner is required to report the income earned from the partnership on his or her personal tax return.
- If the business is not a passive income generating venture, the income is subject to self employment tax. the partner pays self employment tax based solely on his or her share of earnings.
- The federal tax rate for the partner, like a sole proprietor, depends on the personal tax bracket for that individual.
- The total amount of taxes that each partner pays can be vastly different. One partner may be in a federal tax bracket of 15% while another parter may have additional earned income outside the partnership causing him to be in a 35% tax bracket.
- Like a Sole Proprietorship, each partner will have to track net income carefully, and pay estimated quarterly taxes. If a partner does not pay estimated taxes or under pays, he or she may have to write a sizable check when the return is filed.
- Like a Sole Proprietor, a Partner can have a tax liability of 25% to 60% of the net income of the partnership.
S Corporation
- An S corporation is one that passes corporate income, losses, deductions and credits through to shareholders for federal tax purposes. In other words, the earnings or losses by the S corporation, are passed through and recorded on an owner's personal tax return.
- The owner pays taxes on the earnings based on his or her own personal tax rate.
- Unlike a Partnership or Sole proprietorship, an owners of an S Corporation must, by law, take a reasonable and customary salary.
- This type of entity allows the owner to take W2 wages and have income tax, as well as social security taxes, and Medicare taxes to be deducted from their wages.
- It allows owners to take some compensation out as distributions, which are not subject to social security, Medicare taxes.
- A CPA should be consulted to help determine an appropriate salary and reasonable distributions.
- Each quarter an owner takes out a distribution, he or she should pay estimated taxes based on the amount of distributions taken and his or her estimated personal tax bracket.
- The owners of an S Corporation does not have to pay self employment taxes on the income of the business or distributions.
C Corporations
- The C Corporation is the only structure where the income earned by the Corporation does not flow through to the owners personal tax return.
- The corporation is recognized by the IRS as a separate taxpaying entity.
- When people talk about the corporate tax rate, they are referring to the tax rate paid by C Corporations. The tax rate for a C Corporation ranges from 15% to 39%.
- One of the biggest downsides of a C Corporation, for business owners, is double taxation. The Corporation pays taxes on earned income. When the company distributes its earnings, as dividends to its shareholders, the shareholder must pay taxes on the dividends received. This results in income being taxed twice, once at the corporate level and again by the shareholder on their personal tax return.
- Certain circumstances dictate the selection of a C Corporation.
To make things a little simpler we have put together a table that highlights some of the key differences between entities and made that available to you for free.
Over the past several years, it seems like we have been posting negative information for business owners regarding new regulations and the possibility of significant tax increases in 2013.
Taxmageddon is approaching in January, 2013 if Congress, the Senate and the President don't make any changes to the federal tax laws before then.
Well, amidst all the negative news, here is some great news for NC business owners.
Beginning this tax year (2012), NC business owners who have a Sole Proprietorship, S Corporation, Partnership or LLC will be able to deduct up to $50,000 of business income from their state taxes. 
The news is even better if you and your wife are partners or co-owners of one of these entities. The new law allows you to each deduct up to $50,000 of income. So if you are business partners or co-owners, you can deduct up to $100,000 of income between the two of you.
This new income deduction falls under North Carolina statute, N.C.G.S 105-134.6(b)(22) and does not apply to C Corporations or passive income. If you have a rental property or any other investment that generates passive income, you are not allowed to use this income deduction.
A business owner whose business net income exceeds $50,000 can expect to save at least $3,500 on NC state income taxes and for married couples who share ownership of a North Carolina company, that tax savings can double to more than $7,000.
What a great incentive to start a small business in NC. If you are a small business owner or about to start a business, we can assist you. You may contact us here.
Are you a small employer and have fewer than 10 full time employees whose wages average less than $50,000 per year? If so, you can save money in 2010 and even more money in future year.
Eligible small employers may receive up to a 35% tax credit on the portion of the premiums paid for employees in 2010. Even better news for small business owner's is that this credit is scheduled to increase to 50% by 2014.
Now the details. The credit starts to phase out at more than 10 full time equivalent employees and/or when the average salary for your full time equivalent employees (FTE) exceeds $25,000. At 25 FTEs the credit is phased out or if the average wage for your FTEs exceed $50,000.
A Full Time Employee (FTE) is defined as either a full time employee who works 40 hours per week or multiple part time workers whose hours add up to 40 hours per week.
When determining FTEs seasonal workers are typically excluded, unless they work for an employer more than 120 days during the year. A seasonal worker is defined as a worker who performs labor or services on a seasonal basis as defined by the Secretary of Labor. This would include workers employed during the holiday season.
To learn more about the Healthcare Tax Credit download our Healthcare Tax Credit Guide.
Last week Heather M. Rotham published an article Congress Urged to Scrap New Form 1099 Reporting Requirements, in whcih she outlines why it is not a given that new 1099 reporting requirements will go into effect. Previously we did a post here and here on the new 1099 reporting requiremnts.
In her article, Heather outlines the action the US Chamber of Commerce has undertaken to have this piece of legislation reversed.
The U.S. Chamber of Commerce announced Aug. 17 that more than 1,099 companies around the nation have signed a letter to lawmakers asking them to repeal new Form 1099 reporting requirements, calling them burdensome, complex, and very costly.
She also nincludes some of the content of the letter from the U.S. Chamber of Commerce regarding issues we highlighted here and here.
"If this provision is implemented, the 1099 reporting mandate will impose substantial paperwork and reporting burdens on the backs of governments, nonprofits, and businesses-especially small businesses," the companies wrote. "This provision will also serve to dramatically increase accounting costs, expose businesses to costly and unjustified audits by the [Internal revenue Service}, and subject more small businesses to the challenges of electronic filing."
Currently there are at least two proposal for changing the new 1099 reporting requirements. Once lawmakers return from the August recess they will consider changes to the recently passed 1099 reporting requirements as part of H.R. 5297, a small business bill
Here is a video put out by the Center for Freedom & Prosperity. This was put out two years ago. It discusses how the US corporate tax rate is among the highest in the world and how it puts the US at a competitive disadvantage when competing to bring jobs to the US.
In 2008 SC passed a law to address the issue of businesses placing illegal workers on the payroll as employees. The law is being implemented in two phases. The first phase was for larger businesses (those with greater than 100 employees) and the second phase is for businesses with less than 100 employees.
The law requires that a business check all new hires to to verify that they are either a citizen of the US or have a right to work in the US legally. Although the bill applies to checking the new hires, there is a proviosn for existing employees. If a business discovers they may have an employee that does not have a right to work in the US, they must investigate and fire any persons they find working illegally.
Businesses that do not comply can face fines of up to $1,000 per illegal employee. Approximately, 200 violations statewide, through May, were found in violation of the law according to The Department of Labor Licensing and Regulation.
As the law goes into effect this week, for all busineses, it will be closely watched to see its impact on the issue if illegal workers.
Earlier this year, PA launched an aggressive amnesty campaign to collect back taxes owed to the PA Department of Revenue. Apparently, PA's amnesty campaign was extremely effective. According to Governor Rendell, the PA amnesty program brought in $261 million in previously uncollected revenue. The goal of the program was $190 million.
Because of the program's success, the state revenue agency and Governor Rendell plan on implementing new measures to go after additional back taxes owed. The Governor will be requesting additional money to fund the budget to hire additional revenue agents.
It should come as no surprise to anyone, that as the budget shortfall in the majority of states continues to be a problem each state will evaluate ways to collect moneys owed in back taxes. This may include implementing amnesty programs, hiring additional revenue agents and taking a much more aggressive stance in regards to collecting back taxes owed.
Now is not the time to try and evade or avoid paying taxes owed as it can lead to hefty fines, penalties and possible criminal charges for tax evasion.
If you have been in noncompliance with the tax laws, playing around the edges of the tax laws, hiring 1099 contractors, rather than employees and are not worried about an audit, because the chances of an audit are low, then the next couple of posts are a must read for you.
The post, Are You Self Employed or a Small Business Owner? If So, The IRS Is Gearing Up to Evaluate How you Classify Workers, is in regards to the Dept of Treasury's recent Internal Audit Report: Employment Tax Compliance Could Be Improved with Better Coordination and Information Sharing. The othe other post, What Whistleblowers and Hedge Fund Investors have in Common should make you take notice that your business and complaince to tax law will be under the scrutiny of many prying eyes including your employees.
Both posts underscore the seriousness that the IRS is taking regarding tax fraud including the misclassification of 1099 contractors as employees. As the budget deficits grows and additional revenue is needed by the government the logical thing to do is to raise revenue through increased compliance.
Beginning in 2012, all businesses, including sole proprietors, partnerships and corporations will have to issue a 1099 to any person or business when they purchase any goods or services that exceed $600 per year.
That's correct, now when Larry the landscapers buys gasoline from Bill's Stop & Go because he has the cheapest gasoline, and spends more than $600, Larry will have to issue Bill's Stop & Go a 1099. When Joe the plumber purchases more than $600 at Home Depot or Lowe's he will have to issue them a 1099.
Every business, including sole proprietors and consultants, are subject to this new law. No longer will it be enough to have the name of the corporation, it's Employer Identification Number (EIN) and receipts for purchases from them to write off as a business expense. You will now be required to issue them a 1099 and submit that information to the IRS.
For example, a small business owner of an autobody shop or supply store that purchases thousands of items, in a given year, from hundreds of different vendors, will have to issue every vendor, where he spent more than $600, a 1099. This will require a business to spend additional resources and money on 1099 compliance.
The reasoning behind this, is that it will allow the IRS to track all income, to every individual or business where more than $600 was spent in a given year by any one business owner. This little requirement buried in the Health Care Bill places a major burden on all companies across the country. Now managers and owners, rather than spending their time running and growing their business to create jobs, will have to spend their resoucres to deal with this additional, burdensome, tax reporting requirements.
Neil deMausein in his article Health care law's massive hidden tax change, reports on this little hidden gem from the Health Care Bill.
Section 9006 of the health care bill--just a few lines buried in the 2,409 page document--mandates that beginning in 2012 all companies will have to issue 1099 tax forms not just to contract workers but to any individual or corporation from which they buy more than $600 in goods or services in a tax year.
Nancy Pelosi was right when she said they had to pass the bill to see what is in it....a massive new tax filing requirement for all businesses.
Because of the various states' budget crisis and growth of on-line sales over the past decade, a few states have been passing laws in an effort to collect sales tax from -on-line retailers. To date, these states have had little success.
Most recently, the battle lines have been drawn between Amazon, and North Carolina. Last year, NC passed a law requiring on-line retailers to collect sales tax on products sold through NC marketers and affiliate marketers and referral sites. Currently, the NC Department of Revenue has put this number at greater than 350.
During an audit with Amazon last December, NC sate auditors requested detailed information related to Amazon's sales to NC residents. The request was for the NC sales dating back to August 2003. Amazon, citing privacy laws, refused to turn over the information.
Last month NC announced that on-line retailers must sign an agreement by August 31, in which they agree to collect sales tax from on-line sales to NC residents. If they do not, the NC revenue Secretary, Kenneth Lay, has stated NC would go after them for uncollected sales tax dating back to August 2003. This is well before the passage of the law.
As with all things that end up in court, the outcome is any one's guess. Whatever the outcome, you can be sure the decision will be appealed by the losing party. In 1992, the US Supreme Court ruled states could not force retailers to collect sales tax, unless the retailer had a presence in that state. The court reasoned that because the rates in every state, city and county and the products or services taxed were all different, it would be impossible for a retailer to keep track and conform to all the various sales tax laws and rates across the country.
The two states at the forefront of, of this attempt to collect sales tax from on-lin retailers are NC and Colorado. Amazon's strategy to date, when faced with these new state laws, has been to discontinue it's affiliate marketing program in those states. . This action effectively shuts down and hurts the small business owners, whose business model is selling products via, affiliate marketing programs such as ones like Amazon.
Currently more than a dozen other cash strapped states are debating whether to try and pursue the collection of sales tax from on-line retail sales. You can bet that other states will be closely monitoring the court case between Amazon and NC.
Jake Grovum does a great job outlining this issue in his article The Amazon Tax War Escalates, posted on Stateline.org.
If you're in th e-commerce business, you'll want to keep a close eye on these developments.