Congratulations! After paying your dues for years, you have decided to go out on your own and open your own business. You have done all your homework; done your budgets for the next year; opened your bank account; gotten a line of credit or other means of cash flow until you get up and running; plus a plethora of other tasks that needs to be done. But wait! Have you decided the choice of entity your business will take?
The choice of your business entity is one of the most important decisions facing small business owners. As Quickbooks advisors, accountants and CPAs, a basic understanding of how particular entities work is vital in order to correctly advise your clients. This choice will have lasting affects for the entire life of the business. With some owners, the choice of business entity is an afterthought, remembered or brought to their attention by a tax professional when it is time to file their tax return. The choice of entity is a complex decision and no single form is appropriate for every business situation.
Four of the most common forms of business entities are: Sole Proprietors, C Corporations, S Corporations and Partnerships. Based on the latest statistical data from the IRS the most popular form of doing business is the Sole Proprietorship, followed by S Corporations, Partnerships, and lastly C Corporations. This article and future articles will explore the four most popular choices that a small business has to choose from and the advantages and disadvantages of each.
IRS Data of Business Entity Type
If the business has one owner, they may be a sole proprietor or elect to be taxed as a corporation (S Corporation and C Corporation). If the business has two or more owners, the entity may be taxed as a partnership or elect to be taxed as a corporation. There are other more complex forms of entities that we will not address. If you want to explore those other entity choices, contact your local tax professional.
You have several factors that will alter your choice of which entity will be the best for your new business. It is important that you have an understanding of each entity; their advantages and disadvantages; their tax aspects and how that will affect you. Some of the factors that will go into the selection of the entity form are: (1) How do you want to limit the liability exposure for the debts of the entity; (2) Do you want the new business to be taxed as a separate entity or would you like it to flow through to your personal income tax return; and (3) How will payroll taxes come into play for the selected entity choice?
As a new business owner, it is extremely important to also have an understanding of how payroll taxes work. Whether you are going to be an employee of the new entity, or you are hiring employees to assist you in your goals, a working knowledge of how payroll taxes work is also vital. Hopefully sometime in your career, you have worked for other individuals and have experienced how the payroll system works. You get paid a gross amount and from that gross amount the various taxes are taken out. In addition to having to pay federal and state income taxes you are also responsible for Social Security and Medicare Taxes. At the time of this publication, the Employees portion of Social Security tax is 6.2% of gross wages; while the Medicare Tax is 1.45% of gross wages. In addition to matching the employees 6.2% Social Security tax and 1.45% Medicare tax, an employer must also pay federal and state unemployment taxes. The Federal Unemployment Tax, known as FUTA, is paid on the first $7,000 of wages an employee earns. The FUTA tax rate is currently 6.2% but can be reduced to 0.8% with a credit of up to 5.4% for the state unemployment taxes paid. The state unemployment taxes, known as SUTA, vary from state to state, by the percentage and how much of the wages that will be taxed. Check with your particular state unemployment office for the details.
The next series of articles will explore each of the four popular entities and point out the advantages and disadvantages, tax implications and how it will affect you as a new business owner.
Zebee Levet is a CPA with Roy L. Cress CPA, Inc. in Charlottesville, VA. With 30 years of
experience she has specialized in the area of tax and tax resolution. She has also been a Quickbooks Proadvisor since 1997. She and her husband currently live on a 10 acre farm located in Troy, VA.
 Information compiled from data from website http://www.irs.gov/uac/SOI-Tax-Stats-Integrated-Business-Data, Table 1 - Number of Returns, Total Receipts, Business Receipts, Net Income (less deficit), Tax Years 1980-2012.