How Does a Business’s Structure Affect Taxation?

 Posted on May 05, 2022 in Small Business Taxes

During the business formation process, a business’s owner, partners, investors, or shareholders will need to determine how the business will be structured. The selection of a business entity may determine how a company will be organized and managed, and it will also affect the taxes that the business will need to pay. By understanding how taxes apply to different types of business structures, owners or partners can determine which type of business entity will provide them with the most benefits.

Taxation for Different Types of Business Entities

The structure of a business will determine whether income taxes will apply to the business itself or to its owners, partners, and shareholders. If a business is a pass-through entity, profits and losses will be passed through to those who have an ownership share in the business, and individual income taxes will apply to these amounts. 

Some commonly used business entities are taxed as follows:

• Sole proprietorships - This type of business will not be separated from the owner’s personal assets. Because of this, the business’s earnings will be considered part of the owner’s income, and income taxes will apply, although certain types of business expenses may be deducted. The owner will also be required to pay self-employment taxes.

• Partnerships - When two or more people co-own a business, it will be considered a pass-through entity, and each partner will report their portion of the company’s profits and losses on their individual tax returns. The partnership itself will also be required to file an information return to report earnings, losses, and deductions. Since partners are generally not considered employees, they will be required to pay self-employment taxes.

• Corporations - In these cases, a business will be a separate legal entity from its owner or shareholders. If a company is an S corporation, it will be a pass-through entity, but if it is a C corporation, it will be required to pay corporate taxes on the profits it earns. A corporation upon initial formation is taxed as a C corporation. However, the corporation and its shareholders may separately elect to be an S corporation, passing through its income on profits.

• Limited liability companies (LLCs) - This structure is a hybrid of corporation and partnership elements. Owners of an LLC are known as members, and a company may have one member or multiple members, and these may include other corporations or LLCs. An LLC will generally be treated as a partnership and taxed as a pass-through entity, although it may choose to be taxed as a corporation and even elect to be an S corporation.

In addition to income taxes, self-employment taxes, and any corporate taxes that may apply, a business will also need to pay employment taxes for its employees. These taxes will be withheld from employees’ wages and paid to the IRS and to the Employment Development Department (EDD). Some businesses may also be required to pay excise taxes, which may include environmental taxes that apply when using certain types of chemicals, taxes on communications and air transportation, fuel taxes, taxes on the initial sale of trucks or tractors, or manufacturer’s taxes that apply to certain types of products.

Contact Our San Jose, CA Business Tax Lawyer

At John D. Teter Law Offices, we can help you choose the right structure for your business that will minimize the taxes that you will be required to pay, or we can assist in restructuring a business to meet its changing needs. We can also help address federal and state taxation issues that your business may encounter, including assisting with IRS tax audits, EDD payroll tax audits, or tax penalty abatement. To get legal help with business formation and tax-related issues, contact our San Jose business formation and tax attorney at 408-866-1810.

Sources:

https://www.irs.gov/newsroom/irs-recognizes-small-business-week-information-and-free-resources-for-starting-a-business

https://www.irs.gov/businesses/small-businesses-self-employed/business-structures

https://www.irs.gov/publications/p334