From Carol McAtee’s CPA firm in St. Petersburg, FL –When starting a business, new owners need to know their federal and state tax responsibilities. Generally, the form of business entity chosen to operate will determine what taxes need to be paid and how to pay them. Selecting the form of business is one of the first steps in starting a new business. The most common forms of business are the sole proprietorship, partnership, corporation, and limited liability company (LLC).
A sole proprietorship is an unincorporated business that is owned by one individual. It is the simplest form of business organization to start and maintain. This form of business offers no liability protection for personal assets, and the income and expenses of the business are included on the owner’s personal income tax return.
A partnership is an unincorporated business organization existing between two or more people who carry on a trade or business. Each person shares in the profits and losses of the business. A partnership must file an annual information return to report the income and losses from its operations, but does not pay income tax. Instead, income and losses from partnership operations are “passed through” to the partners, and each partner includes their share of the partnership’s items of income and deductions on their personal tax return.
A corporation is a separate legally entity formed to operate the business. Shareholders contribute money or property to the corporation in exchange for stock in the corporation, which represents an ownership interest in the corporation. Being a separate legal entity, a corporation offers liability protection for the personal assets of the shareholders. Profits of a corporation are taxed to the corporation, and the corporation must file an annual tax return and pay the appropriate income tax. Additionally, any profits distributed to shareholders are taxed as dividends on their personal tax returns. However, shareholders cannot deduct any losses from the corporation.
Eligible domestic corporations can avoid the “double taxation” (once to the corporation and again to the shareholders as dividends) by electing to be treated as an S corporation. Generally, an S corporation files an annual information return similar to a partnership, with each shareholder reporting their percentage of the S corporation’s profits and losses on their personal tax returns.
A limited liability company (LLC) is a separate entity formed under state laws. None of the members of an LLC are personally liable for its debts. An LLC can have a single or multiple members, and can elect to be classified as a partnership, corporation, or sole proprietorship for federal income tax reporting.
After selecting the form of business, new owners operating a partnership, corporation (including S corporation), or LLC must obtain an Employer Identification Number (EIN). Sole proprietorships can operate using the owner’s social security number (SSN). Business owners must include their taxpayer identification number (EIN or SSN) on all returns and other tax related documents.
The next two items new business owners must address is the selection of a tax year and accounting method. A tax year is usually 12 consecutive months. There are two kinds of tax years: calendar tax year and fiscal tax year. A calendar tax year is 12 months beginning January 1 and ending December 31. A fiscal tax year is 12 consecutive months ending on the last day of any month except December.
An accounting method is the set of rules used to determine when and how income and expenses are reported. Taxpayers choose an accounting method for their business when they file the first federal income tax return. There are two basic accounting methods: cash and accrual. Once an accounting method is selected, IRS approval is necessary to change to another method.
In addition to the federal tax considerations discussed above, new business owners must also consider and initiate the appropriate state and local tax provisions relevant to their new business operation. State and local taxes include, but are not limited to: sales tax, state unemployment tax, tangible property tax, and state income tax, where applicable.
As discussed, there are many important tax considerations when setting up and starting a business. Professional guidance is strongly recommended. Contact us at McAtee & Associates and we can assist you with the startup of your business including: selecting a business structure, applying for an Employer Identification Number, choosing a tax year and accounting method, determining the appropriate state and local taxes applicable to your business, and filing the necessary initial and ongoing federal and state tax forms necessary for your new business.
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.