Structuring Your Business Based On Your Tax Liabilities

If you're about to open a business, you first need to decide which type of business you're going to open. In general, you'll be deciding between a sole proprietorship, partnership, or corporation. Among other things, the structure of your business will significantly impact your end-of-year tax liabilities. 

The Tax Consequences of a Sole Proprietorship

A sole proprietorship is known as a pass-through entity. Your income from your business is taxed alongside your own income -- essentially, you are simply a self-employed individual who is making money. A sole proprietorship is generally best for those who operate as independent contractors or who run their business alone as it significantly reduces their tax liability at the end of the year. However, a sole proprietorship opens the business owner up to personal liability issues if the business encounters legal or financial issues.

The Tax Consequences of a Partnership

A partnership is designed as a method of constructing a sole proprietorship between multiple entities. A partnership is also a pass-through entity; the partners themselves are taxed based on income and they are only taxed once. Like a sole proprietorship, a partnership offers only limited liability protection. Each partner could find themselves becoming responsible for the debts of the business. As far as tax purposes are concerned, a partnership is the simplest method of constructing a small multi-partner business.

The Tax Consequences of Corporation

A corporation creates an entity entirely separate from the owner or owners. Because a corporation is treated as another entity entirely, it is taxed separately. Thus, it's considered to be double-taxed: Oncome will be taxed once the corporation earns it in addition to being taxed when it is passed on to the owners. Business owners will usually be taking a salary from the company. Though a corporation generally costs more in taxes, it also provides some fairly significant liability protection. Business owners will not be considered to be liable for the debts of the business except under unique circumstances, such as personally guaranteeing a loan.

The structure of your business will determine whether or not you end up being taxed once or twice on your company's income. Further, it also impacts the complexity of your returns—a sole proprietorship is a single return with a new schedule whereas a corporation would require a separate return for individuals and for the business. Your accounting firm can give you more information regarding the potential consequences of your business structuring. Contact a business like HBE Becker Meyer Love LLP to learn more about tax preparation.