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Starting a small business – Income Tax

December 10, 2012

I hate paying taxes.  I hate when my clients have to pay taxes.  I hate when my clients say, “I’m happy that I make enough money to have to pay taxes.”  You really shouldn’t be.  Imagine what you could do with the money if you didn’t have to pay it – give to charity, invest in your business, invest in anything, save for your kids, pass it on to your kids, etc.

If you own a business and it’s profitable, you will have to pay Federal, State and maybe local income taxes on the profit.  There is no way around it.  If you don’t, the government will find out and they will come after you.  There are basically three ways to report and pay income taxes on business income:

  1. as a corporation;
  2. as a pass-thru entity, and;
  3. as an individual.

The method depends on the legal and tax structure of your business.  The rates may be higher or lower for a corporation than the other two methods.  A pass-thru entity is a business that does pay the income tax.  Instead, it passes the income thru to your individual tax return and you pay taxes at the individual rates.

Pass-thru entities include partnerships and S corporations.  Your business is automatically a partnership if there is more than one owner.  S Corporation status is an election that your business makes.  It can be made for qualifying regular corporations, partnerships and single person LLCs.  A Limited Liability Company is a legal entity designed to give corporate legal protections to non-corporate entities.  My business is organized as a single person LLC.  LLC really has nothing to do with taxes unless you elect to be taxed as a C Corporation or S Corporation.

If your business is a C Corporation, the profits are taxes at the corporate level.  The corporation files a tax return and pays any tax due.  The owners do not include the corporate profits on their Form 1040.  They would only need to report dividend income if the corporation paid dividends.

If you are the sole owner of your business, you will report your revenue and expenses on Schedule C of your Form 1040.  The earnings are taxed at individual rates.  You are required to pay estimated taxes on a quarterly basis towards your income taxes from your business.

Selection of a tax entity usually makes sense once your business is profitable with annual net income over $40,000 or you have employees.  Otherwise, for the sake of simplicity, it is probably best to use the default tax entity based on your legal structure.

 

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From → Business, Taxes

One Comment
  1. This was a very informative post. As a small business owner and sole proprietor, I am still navigating the taxes I pay each year and will admit it’s quite a stressful process until I know I will make ends meet.

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