How Your Business Designation Impacts Your Taxes
When starting a new business, one of the first things you’ll have to do is register that business. To do so, you need to select a business structure, also known as a business designation, which can be a foreign concept to first-time business owners. If you’ve never selected a business designation before, it’s important to consider all of the ways in which the structure you choose will impact your company. Business taxes is just one of those impacts you’ll want to look at, and we provide a closer look at how business designation impacts your taxes below.
Why Business Designation Matters
Before we get into the different tax implications of each different business structure, we want to make it very clear that taxes are only one of many things that you should consider before selecting a business designation. The designation you choose can impact your company’s ability to grow and earn money, as well as change who is considered liable if someone brings a lawsuit against your business.
There are nine different business structures you can choose from, and each means something a little different for your company’s future. So, do your research and ensure you select one that works with your vision for your business’s growth. If you’ve already registered your business and decide you want a different designation, it is possible to change it, but there can be consequences for converting to a new business structure.
Now, let’s look at the tax implications of the major categories of business designations, starting with corporations. There are actually many different types of corporations, but the most common ones are C corps and non-profits. Corporations of all types are considered a separate tax-paying entity. This means that the business itself is taxed on the company’s profits, can take business deductions, and so on, just as any other taxpayer would.
As an owner of a corporation, it’s important to note that your profits from the business will be taxed twice—once, when the corporation is taxed on the profits, and then a second time when the dividends are passed on to you and the other shareholders. Corporations also have very strict recordkeeping requirements, so if you select this business designation, make sure you work with professional bookkeepers to keep everything as detailed and accurate as possible.
While non-profits are considered a corporation, they’re taxed very differently from the other types of businesses in this category. Non-profits can register with the IRS for tax exemptions. However, you have to meet and stick to very strict requirements regarding your use of any profits if you want to remain a non-profit.
This is a pretty common selection for first-time business owners, because they’re easy to set up and provide you with the chance to test your business idea before creating a more formal business structure. From a tax standpoint, they can also simplify things a lot, because you report your company’s profits and losses on your personal tax return. Simply file a Schedule C and a Form 1040 with your tax return, and your business taxes are done.
There are two business designations that fit into this category: limited partnerships (LPs) and limited liability partnerships (LLPs). From a tax standpoint, these two designations are essentially the same, operating on a pass-through basis.
This means that the company’s profits and losses are passed on to the partners. Each partner should be issued a K-1 that shows the amount they need to report on their personal tax return. The partner reports their personal share of the company’s income or loss using a Schedule E, filed with their personal taxes. Any pass-through income is subject to income and self-employment taxes
If someone is a “limited partner” in one of these businesses, they would report their share as passive income or passive loss. Passive income isn’t subject to self-employment tax, and passive losses are often limited and can only be used to offset other passive income.
Limited Liability Companies
Limited liability companies, or LLCs, also operate on a pass-through basis. However, LLCs can be taxed differently depending on whether they have a single owner or multiple partners. For single-member LLCs, taxes are handled in much the same way as a sole proprietorship; the owner reports income from the company on a Schedule C and Form 1040. For multiple-member LLCs, profits and losses are passed on to all partners via a Schedule K-1, like a partnership.
If you’re establishing a business, it’s important to consider the tax implications and other legal concerns regarding which business designation you choose. If you have any questions regarding these tax issues, please contact one of our business tax experts.
Camputaro and Associates
Certified Public Accounting Firm
136 N. Orchard Street, Suite 8
Ormond Beach, FL 32174