By Dania Mahmoud
Tax season has arrived, and if you’re ahead of the game, you're already thinking about filing strategies that will give you a tax advantage. You might be looking to minimize your income tax, or maybe you want to reduce the liability your business attaches to you. Choosing the right business structure is the first step towards making tax season an opportunity for advancement.
If you have been thinking about changing your business structure, knowing which tax forms you’ll be filling and defining your long-term goals are important before making that final leap. Here are three questions to help you determine which business structure is best for you:
1. Do you own your business yourself?
Yes, I helm my own ship.
If you’re independent-minded and lead your business on your own, you have a sole proprietorship. Legally, you and your business are considered the same entity. That means all of your business outcomes, whether positive or negative, are considered your responsibility. This makes some things a lot simpler. As a sole proprietor, you won’t find yourself filling out a lot of complicated tax forms. In fact, your business does not incur a separate tax at all because its profits or losses are considered your own. A sole proprietorship is also the most inexpensive business structure to establish. However, it’s also the riskiest. Owning your own business means owning all of its liabilities, including debts, employee actions, and other burdens. If you've taken on a sole proprietorship, check out the IRS’s list of tax forms to file.
No, I’m not going it alone.
If a sole proprietorship doesn’t fit your business, you have several options on the table. If you equally share ownership of your business with at least one other person, you will probably file as a partnership. As in any relationship, you and your business partner will need to decide if you want a long-term or short-term arrangement. This brings us to our next question.
2. How long are you planning on operating your partnership?
I want to be around for a while.
As in any partnership, business partners must consider whether they want their arrangement to be long-term or short-term. If you are planning a long-term operation, you should file as a general partnership. General partnerships assume that the business’s profits, obligations, and liabilities are divided equally between owners. If you have a general partnership, your business will need to file an annual return income, but you will not need to pay a separate income tax for your business. Instead, you and your partners will report your shares of income on your personal tax returns.
I only need a short-term partnership agreement.
If you and your business partners are embarking on a temporary project, you have a couple options. You can file as a joint venture partnership, which is the short-term version of a general partnership. Partners in a joint venture share the responsibilities and profits associated with their business equally. However, this agreement stands only for a limited amount of time. If you want to file your business as a joint venture or a general partnership, check out this list of tax forms.
Another short-term partnership option to consider is a Limited Liability Company, or LLC. For tax purposes, an LLC is like a partnership because it is not considered a separate entity. Once again, your business will not have to pay its own income tax. Unlike a general partnership, an LLC offers your personal assets more protection from any liabilities your business may incur. An LLC also allows you and your partners to distribute profit between yourselves as you see fit. Instead of sharing profits equally, partners have the option to reward those who have contributed a greater amount of effort to the business.
3. How many shareholders have invested in your corporation?
I have more than 100 shareholders.
If you want to sell shares of your business to investors, you are looking to own a corporation. Unlike the business structures discussed above, corporations are separate entities that are liable to “double-taxation”; profit is taxed when earned and later when distributed to shareholders. If you have more than 100 shareholders, you’re probably on your way out of the world of small business. Because of the costs associated with corporations, most small businesses will not file as one.
I have a corporation with less than 100 shareholders.
If you sell shares but are not as large as a corporation, you could benefit from filing as an s corporation. S corporations operate as separate entities, so like corporations, they offer more protection of shareholders’ assets. S corporations, however, are able to avoid double taxations. Profits and losses are recorded on shareholders’ personal tax returns rather than filed for the business itself, just like in a partnership. While s corporations have the potential to save a lot of money this way, it is important to note that shareholders who are also employees must pay themselves a fair amount of wages so that they do not avoid paying taxes altogether. In order to qualify to be an s corporation, a business must be a domestic corporation, have 100 shareholders or less, and have shareholders who are only individuals, estates, or certain organizations and trusts. If your company qualifies, check out the IRS tax files for an s corporation.
Sources
U.S. Small Business Administration
IRS.Gov
Tax season has arrived, and if you’re ahead of the game, you're already thinking about filing strategies that will give you a tax advantage. You might be looking to minimize your income tax, or maybe you want to reduce the liability your business attaches to you. Choosing the right business structure is the first step towards making tax season an opportunity for advancement.
If you have been thinking about changing your business structure, knowing which tax forms you’ll be filling and defining your long-term goals are important before making that final leap. Here are three questions to help you determine which business structure is best for you:
1. Do you own your business yourself?
Yes, I helm my own ship.
If you’re independent-minded and lead your business on your own, you have a sole proprietorship. Legally, you and your business are considered the same entity. That means all of your business outcomes, whether positive or negative, are considered your responsibility. This makes some things a lot simpler. As a sole proprietor, you won’t find yourself filling out a lot of complicated tax forms. In fact, your business does not incur a separate tax at all because its profits or losses are considered your own. A sole proprietorship is also the most inexpensive business structure to establish. However, it’s also the riskiest. Owning your own business means owning all of its liabilities, including debts, employee actions, and other burdens. If you've taken on a sole proprietorship, check out the IRS’s list of tax forms to file.
No, I’m not going it alone.
If a sole proprietorship doesn’t fit your business, you have several options on the table. If you equally share ownership of your business with at least one other person, you will probably file as a partnership. As in any relationship, you and your business partner will need to decide if you want a long-term or short-term arrangement. This brings us to our next question.
2. How long are you planning on operating your partnership?
I want to be around for a while.
As in any partnership, business partners must consider whether they want their arrangement to be long-term or short-term. If you are planning a long-term operation, you should file as a general partnership. General partnerships assume that the business’s profits, obligations, and liabilities are divided equally between owners. If you have a general partnership, your business will need to file an annual return income, but you will not need to pay a separate income tax for your business. Instead, you and your partners will report your shares of income on your personal tax returns.
I only need a short-term partnership agreement.
If you and your business partners are embarking on a temporary project, you have a couple options. You can file as a joint venture partnership, which is the short-term version of a general partnership. Partners in a joint venture share the responsibilities and profits associated with their business equally. However, this agreement stands only for a limited amount of time. If you want to file your business as a joint venture or a general partnership, check out this list of tax forms.
Another short-term partnership option to consider is a Limited Liability Company, or LLC. For tax purposes, an LLC is like a partnership because it is not considered a separate entity. Once again, your business will not have to pay its own income tax. Unlike a general partnership, an LLC offers your personal assets more protection from any liabilities your business may incur. An LLC also allows you and your partners to distribute profit between yourselves as you see fit. Instead of sharing profits equally, partners have the option to reward those who have contributed a greater amount of effort to the business.
3. How many shareholders have invested in your corporation?
I have more than 100 shareholders.
If you want to sell shares of your business to investors, you are looking to own a corporation. Unlike the business structures discussed above, corporations are separate entities that are liable to “double-taxation”; profit is taxed when earned and later when distributed to shareholders. If you have more than 100 shareholders, you’re probably on your way out of the world of small business. Because of the costs associated with corporations, most small businesses will not file as one.
I have a corporation with less than 100 shareholders.
If you sell shares but are not as large as a corporation, you could benefit from filing as an s corporation. S corporations operate as separate entities, so like corporations, they offer more protection of shareholders’ assets. S corporations, however, are able to avoid double taxations. Profits and losses are recorded on shareholders’ personal tax returns rather than filed for the business itself, just like in a partnership. While s corporations have the potential to save a lot of money this way, it is important to note that shareholders who are also employees must pay themselves a fair amount of wages so that they do not avoid paying taxes altogether. In order to qualify to be an s corporation, a business must be a domestic corporation, have 100 shareholders or less, and have shareholders who are only individuals, estates, or certain organizations and trusts. If your company qualifies, check out the IRS tax files for an s corporation.
Sources
U.S. Small Business Administration
IRS.Gov
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