Taxes and Businesses

If you are thinking of starting up a business, one thing that you will have to take into account is taxes. Taxes and businesses always go together. However, depending on the type of business entity used, the business will be taxed in different ways. Below is a brief description of the ways different types of business entities are taxed.

Sole Proprietorship
A sole proprietorship is when a single person operates a business and the owner has taken no action to form another type of business entity. In this situation, the individual owner is taxed on the business income. The sole proprietorship itself is not taxed. The income and expenses will instead pass through to the individual owner's personal income tax return.

Partnership
A partnership is a business entity where two or more people form a business. A partnership is a pass through entity, meaning that the income and deductions pass on to the individual partners. This is very similar to a sole proprietorship. The income and deductions are not necessarily split evenly between the partners. The partnership agreement will state how the income and deductions are to be shared.

Corporations
A corporation can be a very tricky entity, which is why it is important to understand the relationship between taxes and businesses. A standard corporation has double taxation. This means that the corporation is taxed on its profits, and then when the corporation pays dividends to its shareholders, the shareholders are then taxed on the dividends they receive.

To combat this double taxation, a corporation can elect to be a S corporation. An S corporation does not have double taxation. Similar to a partnership, the income and deductions pass to the shareholders.

When creating a corporation, it is important to pay attention to state income tax rules. Some states will tax corporations differently than under federal taxation. The corporation may be liable for state taxes in both the state where it incorporates and the states where it conducts business.

Limited Liability Companies
Limited liability companies (LLCs) combine aspects of a partnership and a corporation. A LLC has limited liability, similar to a corporation, but it also does not have double taxation, like a partnership. So, if you form a LLC, you should be familiar with the laws regarding partnership taxation.

Tax Avoidance Versus Tax Evasion
It is important as you plan to minimize your tax burden that you understand the difference between tax avoidance and tax evasion. Tax avoidance is using the tax laws to minimize your tax liability. There is nothing wrong with tax avoidance. Tax evasion, on the other hand, is not paying taxes that you do owe. Tax evasion is a crime and you can face serious consequences if you do so.

Seek Professional Advice
If you need to learn more about taxes and businesses, you should contact professionals who work in the field. Accountants and tax attorneys will be able to help you know what type of business entity is best for your circumstances and help you understand how you can minimized your tax liability.

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