Inadequate information on taxing system when starting a business can lead to significantly reduced profits and you may even end up closing the doors. Tax evasion is illegal and can be vital but looking for ways to reduce the amount you pay on taxes is not therefore one should have proper advice on this. If you don’t have experience in this, hire a trained tax planner to plan ways for your business to reduce its tax burden.
Types of tax systems for businesses
Corporate double tax – this is where the business and the owners are taxed separately. The business is taxed on the money it generates while the owners are taxed on the profits or dividends they get from the business. This system is used for a business corporation referred to as C corp. In this system, losses are not passed to the owners and are deducted only against profits.
Pass through taxation - in this system, the business is not taxed but the owners of the business are taxed on the income they earn from the business. In this method, losses are directly deductible by the business owners who use the system. This system is normally applied to:
* Partnerships with limited liabilities
* S corporations and
* Limited liability companies
It’s normally upon the business owner to make a wise decision on which tax system to adopt. It is advisable for new business owners who are likely to make losses at first to start with the pass through taxation so that they can deduct the losses against other income.
Understanding business entities
Partnerships- these do not have limited liability under the state law. However, they can be limited where the business is taken as a separate entity from its owners for example in corporations. In this case, the owners of the business remain passive in management of the business. Tax treatment is different for both general and limited partnerships.
S and C corps- S corp is an entity named from a chapter of the tax code and it’s a corporation with limited liability under state law. The owners of S corp adopt pass through taxation where they escape federal corporate tax after complying with some rules. C corps are taxed as corporations.
Limited liability companies (LLC) – these business entities have limited liability features and they adopt the pass through tax system. LLC members with limited liability can take active management of the business without affecting their liability.
Clearly understanding each business entity and tax systems is the first step towards having a good tax plan for your business.
Contact me at firstname.lastname@example.org for a free 1 hour consultation. I can help you to understand the tax consequences associated with any of the business entity types shown above, as well as sole proprietorships.