Small Business Taxation by Entity Type
Navigating the tax landscape as a small business owner can be complex. Understanding how your chosen entity type impacts your tax obligations is crucial for financial planning and compliance. Here's a breakdown of small business taxation in the U.S. for different entity types:
1. Sole Proprietorship:
Taxation: Income and losses "pass through" to the owner's personal tax return, taxed at individual income tax rates.
Filing: File taxes using Schedule C of Form 1040 and pay self-employment tax (SE tax) for Social Security and Medicare.
Pros: Simple filing, no separate tax return required.
Cons: Unlimited personal liability, double taxation on Social Security and Medicare self-employment tax.
2. Partnership:
Taxation: Profits and losses "pass through" to individual partners' personal tax returns, taxed at individual income tax rates.
Filing: File personal tax returns and Form 1065 to report partnership income and losses.
Types:
General Partnership (GP): All partners share unlimited liability for business debts and lawsuits.
Limited Partnership (LP): Limited partners have limited liability, while general partners have unlimited liability.
Limited Liability Partnership (LLP): All partners have limited liability.
Pros: Flexible structure, potential tax benefits for LPs and LLPs.
Cons: Unlimited liability for some partners, complex partnership agreements needed.
3. Limited Liability Company (LLC):
Taxation: Can choose to be taxed as:
Sole proprietorship/Partnership: File Form 1040 with Schedule C or E and pay SE tax.
S corporation: Avoid double taxation, file Form 1120-S and pay shareholders payroll taxes.
C corporation: File Form 1120 and pay corporate income tax, then dividends taxed at individual rates (double taxation).
Pros: Limited liability protection, flexible tax options.
Cons: More complex setup and maintenance than sole proprietorships.
4. Corporation:
Taxation: Double taxation - corporation pays income tax on profits (Form 1120), then shareholders pay income tax on dividends received.
Pros: Strong liability protection, potential for raising capital through stock issuance.
Cons: Most complex and expensive to set up and maintain, subject to double taxation.
5. S Corporation:
Taxation: Limited to 100 shareholders who are U.S. citizens or resident aliens. Profits and losses "pass through" to shareholders' personal tax returns, taxed at individual income tax rates.
Pros: Avoids double taxation, offers limited liability protection.
Cons: Strict eligibility requirements, additional filing requirements compared to sole proprietorships.
Additional Considerations:
State and local taxes may apply in addition to federal taxes.
Consult with a tax professional to determine the best tax strategy for your specific business entity and situation.
Tax laws can change, so stay updated on current regulations.