New Business Set-up: Frequently Asked Questions

If you are a small business owner or self-employed you have to make several decisions starting from the right business tax structure to maintaining your books of accounts. Here are some examples of commonly asked questions by new business owners regarding setting up the new company:

Q: Is it important to consider all types of business tax structures for my new company, even though it is just a small business?

It is advisable to compare all business tax structures and their tax treatments before starting your business to save tax dollars and choosing the right business tax structure for you. The tax implications for your new business will have direct impact to your personal taxes and wealth.

Q: I am starting a new small business in online sales, can I set up my business as a Sole Proprietorship? What are the advantages or disadvantages of Sole Proprietorship for new company set up?

Sole proprietors pay tax on their business income on their personal income tax return. The IRS calls it "pass-through" tax as business profits pass through the business and are taxed on the personal income tax return.

Sole proprietors must report all business income and expenses on Schedule C, E or F which is attached to Form 1040. The tax is paid on net income after deducting all operating costs, advertising and travel expenses. Certain start up costs can also be deducted.

The sole proprietor may also be liable for self-employment tax and/or estimated tax payments through out the year depending on the net business profits.

Q: I am planning on starting a new IT Consulting company and considering an S Corp structure for my new business. Can you explain what the tax effect of the S Corp will be on my new company as well as my personal income tax?

S Corporations  are eligible domestic corporations which can avoid double taxation (once to the shareholders and once to the corporation) by electing to be treated as an S Corporation. S corporations are exempt from federal income tax except on certain income from capital gains and passive income.

S corporations have to use Form1120S to file their tax return due on March 15th of each tax year.. S corporations may be liable for estimated taxes and employment taxes. S Corporation shareholders have to include their share of corporation's income, deductions, losses and credit on their income tax.

Q: I have an S Corp, do I have to pay Employment Tax on salary paid to myself?

Yes, in an S Corp, only the salary paid to the employee-owner is subject to employment tax. The benefit of S Corp is that the remaining income that is paid as a distribution is not subject to employment tax under IRS rules. Therefore, there is the potential for substantial employment tax savings.

Q: How is a C Corp different from an S Corp. Can you explain the tax differences in C Corp Vs S Corp?

C Corporations are separately taxable entities. A corporate tax return is filed reporting all the profits and losses and all the profits are taxed at the corporate tax rate. C Corporations may face double taxation as profits are taxed at corporate level and dividends paid to shareholders are taxed at their personal income tax level. This is the biggest difference between C Corp Vs S Corp from a tax perspective.

C Corporations file their tax return using Form 1120 or 1120A. They may be liable for employment taxes and estimated tax payments.

Q: Why are LLCs so popular? What are the advantages of setting up a new company as a LLC?

LLCs are very popular because of their similarity to corporations, giving limited liability to owners and at the same time giving management flexibility like partnerships. Most states allow "single member" LLC i.e. having one owner only. Such LLCs can file their tax similar to that of sole proprietorships by filing Sch C, E or F along with their Form 1040. If the only single member is a corporation then the income and expenses are reported on Form 1120 or 1120S.

Multiple member LLCs file their return using Form 1065. The owner of an LLC is considered to be self-employed and, as such, must pay a "self-employment tax" which goes toward Social Security and Medicare. The entire net income of the business is subject to this tax at a rate of 15.3%.

Q: How does a partnership company operate in terms of the Income Tax treatment?

Partnership companies do not pay income tax but must file an annual information return reporting all income, losses, deductions and gains. All profits and losses are "passed through" to the partners who report the profits or losses on their personal income tax return.

Partners must receive Schedule K-1 from the partnership before the date the company is required to file Form 1065 (including extensions). A partnership may also be liable for employment taxes.

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