Please note that is NEVER advisable for a business owner to prepare the business tax return themselves.
The tax laws governing the different types of businesses are simply too complicated for any non-professional to fully understand and utilize effectively.
Business owners should ensure that their tax preparer is, at minimum, degreed and has at least two years experience in preparing tax returns for their type of business.
A proprietorship is a business that is owned by one person that has not been Incorporated.
This form of business is easiest to set up since it requires little to no official tax paperwork other than what is required of an employer or for sales tax purposes if either condition applies.
The owner has absolute authority and responsibility for all the operations, debts and income of the business.
Many proprietorships are run as home-based businesses which afford the owners a great many tax breaks including: deduction of a portion of their rent or mortage payments, utilities, repairs and maintenance; all auto mileage related to the conducting of business is deductible since the office is at home; there are deductions for self-employment tax and self-employed medical costs as well as the opportunity to employee their non-adult family members whose wages, within certain limitations, will be deductible to the business without being taxable.
The owner will pay tax ONLY on the profits of the business and not on gross receipts. In many cases, profits can be reduced or completely negated by home-office expenses and depreciation which are not true out-of-pocket cash expenses to the owner. However, any money the owner pays him/herself is NOT deductible to the business as an expense.
The owner files a Form 1040 long form with a Schedule C for the business, Form 4562 for depreciation and a Schedule SE for their self employment tax. If there is a home office, Form 8829 will also need to be included.
The primary disadvantage is that the owner is responsible for ALL their social security tax which is about 15%. He/she can deduct 1/2 from his net income on his tax form, but he/she must plan for that tax bite at the end of the year. The best way is to put about 20% of the net monthly profit of the business into a special savings account. The second disadvantage is that there is NO legal protection of personal assets since there is no separation between owner and business.
As stated above, it is not a good idea for any business to try to do the business taxes themselves. This is especially true of proprietorships in light of the fact that the tax laws concerning proprietorships are spread throughout the IRS tax code.
A partnership is a non-incorporated business which is owned by two or more entities. An entity can be an individual or a business of some sort.
This is the next simplest form of business to start. There are only two pieces of official paperwork required (other than sales tax information if applicable). The first is a written agreement between the partners which outlines how they will determine the ownership and responsibility of the assets and liabilities and how the profits and losses are to be divided. The second is an Employer Identification Number. This number is required even if the business has no employees. It is used to identify the business for tax purposes.
This form of business has several advantages. There is more than one person responsible for all the expenses and the responsibilities and work are usually shared. Guaranteed wage payments (a very specific tax term) to the partners are deductible expenses to the business. There is some legal protection of personal assets (not much) for the owners. And, like a proprietorship, the owners pay tax ONLY on the profits of the business split between the owners per percentages outlined in the partnership agreement.
However, unlike the proprietorship, there is a completely separate set of tax forms that must be filed just for the partnership and then the owners must file their personal returns separately. The Form 1065, Partnership Return, and its related schedules K, L, M and K-1 must be prepared by a professional tax preparer experienced in partnership returns. The tax laws are extremely complicated for this form of business, especially when it comes to getting rid of a partner or changing the percentage of ownership of any of the owners.
A regular Corporation (also referred to as a C-Corp for tax purposes) is a legal business entity that has filed appropriate paperwork called Incorporation Papers with the appropriate state authorities and has sold and issued stock to its owners. It can have as few as one owner (called a shareholder). There are no upper limits on the number of owners a corporation may have. Each shareholder is an owner and becomes so by buying shares of stock in the corporation.
A Corporation is the most complicated and expensive form of business to set up and more complicated to get rid of. It is nearly always essential for an Attorney to compile the Incorporation Papers which can get costly and filing the papers with the State costs money as well.
Its primary advantages are that all officer and employee salaries are deductible as expenses to the business; raising capital is, generally, a matter of selling more stock; and there is a greater protection of the owners’ personal assets.
One of the major disadvantages is that it is required to pay Federal Tax on its net earnings separate from the owners and must pay annual Franchise Taxes to the State. Corporations used to be taxed at preferred rates. This is no longer the case. Also, the tax return is due 2 1/2 months after its year-end rather than 3 1/2 months.
A Corporation with fewer than 75 shareholders is eligible to be treated as an S-Corporation for tax purposes. This tax status must be CHOSEN with the filing of a special tax form.
The S-Corporation has the advantages of being treated as a partnership for tax purposes in that net earnings flow through to the owners who report it on their personal tax returns which is divided based on their percentage of ownership. It also has with all the legal advantages of the Corporate limited liability and ability to sell stock for capital.
Unfortunately, it still has to pay State Franchise Tax and file its return in 2 1/2 months.
Limited Liability Company (LLC)
Again, this is a legal, not a tax designation.
They are owned, usually treated as a partnership, but not always. It can be any form of business that chooses to be a Limited Liability Company.
It is characterized as a partnership for tax purposes with all the same advantages of flow-through of income/loss to the owners. It may choose to be treated as a Corporation or an S-Corporation for tax purposes but it must do so in writing.