Taxes are one of the main factors that determine how your business is classified. Continue reading to learn more about the IRS situation that you will find yourself in depending on what type of business you run.
Unincorporated businesses are sole proprietorships. This type of business may have tax obligations that include withholding income tax, Social Security and Medicare taxes, in addition to federal unemployment tax, income tax, and other taxes.
In the business world, a partnership is a relationship where two or more individuals have the intention to do business or trade in varying situations, in which each individual contributes money, assets, labor, or skills, and also shares in the profits or losses.
You must report all income from your partnership business, including any gains, losses, and deductions. This is done via an annual information return. Each partner must report his or her share of losses and profits from the partnership on their personal tax returns. The partnership is required to report its entire tax-related financial information on Schedule K-1.
Each partner may be required to submit the following information and forms:
- Form 965-A: Individual Report of Net Tax Liability under 965
- Schedule E to Form 1040 Supplemental Income Loss.
- Forms for self-employment, tax estimation and international tax, if applicable.
State statutes allow LLCs to be used as business structures. For federal tax purposes this classification is either a corporation, or a partnership.
The people who have exchanged money or property for the stock of the corporation are those who constitute prospective shareholders. A corporation can generally claim the same deductions as a sole proprietorship. A corporation may be able to take additional deductions over and above those of sole proprietorships.
S corporations are limited to 100 shareholders. S corporations are not available to all businesses, but those who are are able to take advantage of the benefits that come with the designation. These include the ability to pass through corporate income and losses, as well as the deductions and credits for federal tax purposes.
Shareholders are required to report their flow-through losses and income as part of personal tax returns. The tax due will be calculated based on the individual tax rate, so they won’t have to pay twice as much tax for their corporate income. S corporations must also pay taxes at the entity level on passive income and built-in gains.
The following forms are required for each type of business:
- Form 1065 is for partnerships or LLCs.
- Corporations: Form No. 1120
- S corporations: Schedule K-1, Form 1120S.
Corporate entities and pass-through
Small businesses with a similar structure as S corporations, LLCs or sole proprietorships are called pass-through businesses. Pass-through businesses account for 95% of U.S. business.
Tax Reform Laws and Standards
In 2017, a tax law reform offered a 20% deduction. However, new standards for 2022 will phase out this law, reducing the taxable income level from $170.050 to $220.050. Income levels for joint filers are adjusted from $340,100 to $440,100. The phase-out limit is currently $182.100 for single filers, and $340.100 for joint filers, as of 2023.
These limits will expire 2027. Businesses cannot deduct losses exceeding $540,000 for married couples filing jointly, since the 2017 tax law is temporarily suspended. Single filers are allowed to deduct up to $270,000.
All business income and losses are included in this information. This includes both Schedule C income and loss and that of pass-throughs. If you have losses above the annual limit, you can carry them forward to the following year in order to lower your taxable income.
Business losses can no longer be used to offset W-2 wage. Additionally, spouse income is taxed differently, so spousal earnings could result in an additional tax bill, regardless of whether business losses are greater than the total spousal earning. Small-business owners that received more than $600 in digital income from third-party platforms like Amazon, Etsy, or eBay will also receive Form 1099K to report this type of revenue after 2023. Platforms must also report this income. The pushback by businesses and taxpayers led to a delay of the 2023 Form 1099K until 2024.
This article is only a brief overview of a very complex subject that requires you to make some difficult decisions. Work with professionals in the financial and legal fields who can answer any questions you may have about your business.