More taxpayers than ever before are starting home-based businesses. Some are working as newly independent contractors in the same fields where they worked as employees, while others are opening totally new fields of venture. No matter what your situation, the business structure you choose affects many issues, including exposure to liability and how your business income is taxed. It can also affect your financing and your ability to grow the business.
The most common business entities are Sole Proprietorships, Partnerships, Limited Liability Companies, S Corporations and C Corporations. I will discuss most of these below and save the details of partnerships for a future post.
Sole Proprietor
Your home business income and expenses can often be reported on your personal tax return on Schedule C, Profit or Loss from Business. Schedule C works to report income or loss from a business you operated or a profession you practiced alone, as a sole proprietor. To qualify as a business, your primary purpose must be for income or profit, rather than a hobby activity. You must be involved in the business “with continuity and regularity.”
Filing a Schedule C also enables you to get tax advantages for business-related expenses, which may include the cost of a home office and miles driven to operate your business. Any resulting profit is typically considered self-employment income, subject to self-employment tax.
You can report a loss on your business, but the IRS will only allow you to claim losses for three out of five tax years. If you don’t show that your business is starting to make a profit in that time, then the IRS may question whether you have a legitimate business, leading to a possible audit or prohibition from claiming your business losses on your tax return.
As a sole proprietor, there is no distinction between you and your company. If the business incurs debt or is subjected to a lawsuit, you are personally responsible, with your personal assets at risk of seizure.
Limited Liability Company (LLC)
Operating as an LLC offers you protection from personal liability for debts and other obligations that a business might incur. It also enables you to open a bank account in the name of the business and gives you a better opportunity of getting funding in the future through a business credit card or loan.
With an LLC, you can still report business income or losses on the Schedule C, meaning the business is taxed through your personal tax return, known as a “pass-through.” An LLC with multiple owners is considered a partnership, with each owner reporting profits and losses on their personal tax returns.
The LLC is required to be filed with the Florida Department of State, Division of Corporations. There is an initial setup fee and a fee for brief but required annual reports.
S Corporation (“S Corp”)
Incorporating as an S Corporation also enables you to do a pass-through to your personal tax return, though you must also complete a separate tax return for the business. A business must meet specific guidelines by the IRS in order to qualify as an S Corp.
An S Corp also protects your personal assets from any corporate liability. And the pass-through income in the form of dividends or salary enables you to avoid double corporate and personal taxation (see C Corporation below). Your business losses can be written off on your personal tax return as well.
S Corps help companies establish more credibility as corporations. Your S Corp can have up to 100 shareholders – required to be U.S. citizens — and pay them dividends or cash payments from the company’s profits.
The S Corp structure also facilitates the qualified business income deduction (QBID), a tax deduction that allows eligible self-employed and small-business owners to deduct up to 20% of their business income on their tax returns. You can claim the qualified business income deduction whether you itemize or take the standard deduction.
Income limits apply to the QBID: For tax year 2022, total taxable income must be under $170,050 for single filers or under $340,100 for joint filers to qualify. If you’re over that limit, complicated IRS rules determine whether your business income may qualify for a full or partial deduction.
S Corps cannot be owned by other S Corps, C Corporations, LLCs, or trusts. For companies that are hoping to get acquired at some point, this could complicate the eventual sale of the business.
C Corporation (“C Corp”)
C Corporations are considered the default type of corporation. When you file articles of incorporation in your state, you’re designated a C Corp unless you file specifically as an S-Corp.
Unlike the S Corp, C Corps actually get taxed twice: The company pays corporate income tax and then the shareholders pay income tax on their personal tax returns from dividends they receive. And C Corps don’t allow tax write-offs for owners on their personal income tax returns.
C Corps have no restrictions when it comes to ownership. Anyone can be an owner, and there can be as many owners as you’d like. If you’re planning on selling stock to potential investors or selling your company in the future, a C Corp is preferred.
With a C Corp, you can deduct 100% of the company’s charitable contributions and donations on your corporate tax return, as long as the donations don’t exceed 10% of your company’s income. You can also help employees by deducting certain benefits, like health insurance, for your employees.
Deciding on Your Business Structure
When you are considering starting a business or changing your business structure, the experts at Carol McAtee & Associates can provide expert Due Diligence services and facilitate the creation of a Sole Proprietorship, Partnership, LLC, or Corporation (SubChapter C or S). Florida Incorporations can be completed in as little as 48 hours. We will work with you to analyze the most beneficial business structure arrangement to meet your business objectives.
If you have questions about this featured topic or other accounting and tax related topics, please do not hesitate to contact us at 727-327-1999 OR [email protected].
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.
