Starting A Business? Know The Right Structure And Taxes
Assuming you have worked out your business plan and objectives, the next step is to dip your feet in the legal requirements to run a successful and state-compliant venture. This involves determining a trademark name and the legal structure. It also includes registering with the appropriate state body to ensure regulatory compliance. Once your business gets registered, the government allocates its unique tax code or number.
It is essential for any business – big or small – to be tax compliant for numerous reasons. However, what is more, important is getting the gist of your business structure and taxation requirements correct. You can quickly identify the do’s ad don’ts of taxation online,e but that will only help if you start right.
Your business structure will determine your tax liability
Why does the business structure matter? For starters, each type of business structure has different legal requirements and tax percentages. It also determines the amount of paperwork needed according to the liability the owner is willing to take upon her/his shoulders. There are four general types of business structures that are followed globally:
- Sole Proprietorship
It is wholly owned and run by a single proprietor. There is less paperwork involved as the government does not distinguish between the owner and the business. Instead, the government considers them as a single entity. The tax liability is also straightforward as this type of business is not taxed separately from the owner. Suppose one wishes to educate themselves further in taxation laws. In that case, one can complete an LLM in tax and develop a better understanding. Or even better, pursue a career in the field. All assets and liabilities are shared between the company and the owner. In case of liquidation, the owner will have to face the penalty of debt settlement.
Partnerships fall under legal requirements similar to that of a sole proprietor. Owners of a partnership business are not viewed as separate legal entities by the government. Similar to a sole proprietor, all assets and liabilities are shared by the company and the owners. If a partnership business were to liquidate, the owners will divide the assets and liabilities equally or based on their profit-sharing ratio.
- Limited Liability Company
An LLC is a hybrid form of a partnership business that has gained significant traction over the years. It takes the best of both worlds: profit, loss, and tax advantages of a partnership business, without the personal liability of owners in case of liquidation. This structure of organizing your business offers limited liability without subjecting the company to an individual tax level.
Unlike corporations that are taxed independently from their owners, the owners of an LLC are taxed instead of the LLC itself. In terms of legal requirements and paperwork, LLCs require more documentation compared to sole proprietors. However, in comparison to a corporation, an LLC is more straightforward to establish and subject to fewer formalities.
A corporation is a separate legal entity registered by the regulatory authority of that state. It is considered distinct from its founders. A corporation, like an individual, can be held accountable and taxed without imposing any liability on its owners. While shareholders of a corporation enjoy avoidance of personal liability, it comes at the cost of extensive paperwork, documentation, and bookkeeping.
Moreover, corporations are taxed differently than regular individuals and often have to follow stringent laws and face strict audits. A significant drawback of corporations is double taxation. A company gets taxed on any profit it records, whereas the shareholders also have to pay taxes on any income and dividends they receive as compensation from the company.
- Understand any licenses or permits that state law requires
After choosing the type of business structure, it’s time to research any additional permits or licenses required to operate within your niche. A “Seller’s Permit” is a common requirement by several states. It is usually applicable if a business trades intangible products such as jewelry, clothing, vehicles, construction, or other physical goods. A permit might also be necessary for service-based industries. Lawyers, therapists, and accountants are also required to charge sales tax from their customers. Therefore, businesses that charge sales tax are legally bound to acquire a permit.
- Types of business taxes you will be required to pay
The types of taxes a business/company are liable to pay include state and federal taxes. All businesses except partnerships are required by law to file an income tax return at the end of each fiscal year. There are three common types of additional taxes that a business will incur:
- Self-employment tax
As the term suggests, business owners incur a self-employment tax. They must pay a tax on their earnings since their tax liability is not separate from their business.
- Employees tax
When a business hires employees, there are specific responsibilities such as social security, medical insurance, and withholding tax on salaries that the employer must pay. These taxes vary from state to state and are determined by the industry’s legal obligations and the number of employees working.
- Excise and taxation
It is not uncommon for businesses to own vehicles and assets for their operations. The government requires taxes on registering said motor vehicles and assets. The value of said assets tends to depreciate in a business’ books over time.
Taxation may seem daunting at first. Consulting a tax professional will reduce the uneasiness that may come with dealing with one’s business taxes. A professional might guide you in the right direction, but there is no alternative to self-education. To run a business, one should also understand its nature and taxation laws by working alongside lawyers and accountants.