One of the first issues you must solve when crafting your business is the form of business entity your business will take. This will determine the amount of personal liability you take on, and the amount of income tax you pay. And, it is the latter on which this Maumee, Ohio, blog post will focus.
The IRS recognizes several businesses entities, including sole proprietorships, partnerships, corporations and S corporations. It also recognizes Limited Liability Companies, but those business structures are entities based on state statutes.
SPs are owned by a greater Toledo metro area person who is unincorporated. You are taxed directly, which means you get all of the deductions and write-offs from the business.
Partnerships are between two or more people who operate a business together. Like SPs, the entity itself is not taxed. Instead, the profits and losses pass through to the partners and each partner pays their own share of taxes. However, the partnership does file an annual return that reports the income, deductions, gains, losses, etc., that pass to the partners, even though the taxes based on them are paid on the partner’s returns.
It should be noted that even though taxes pass through to the partners, the partners are not Form W-2 employees. Instead, the partnership furnishes Form 1065s (Schedule K-1) to each partner for their personal tax returns.
Unlike SPs and partnerships, corporations are separate taxable entities that are taxed separately from the owners. In a corporation, shareholders exchange something of value (property, assets, money, etc.) for the corporation’s stock, which is based on the number of stocks, which gives each shareholder a percentage of ownership. They can use the same deductions as SPs but have additional C corporation deductions as well. Then, after it pays taxes, it distributes profits to its shareholders, who then pay taxes on those distributions. This is why corporate profits are said to be double taxed.
S corporations are a type of corporation, but they have elected to pass all income, losses, deductions and credits directly to the shareholders. This is then reported to the IRS on the shareholder’s individual taxes, which avoids C corp. double taxation. However, not all gains and passive income can be passed on, and there are strict requirements for S corporations, which is why many people need attorneys to maintain this entity structure. In future posts, we will explore northwest Ohio LLCs.