Tax basics for any business entity
Wondering how you’ll be taxed as a small business? Tax regulations can seem overwhelming for any entrepreneur, yet it’s a topic you need to explore when starting your business. Watch this video to find out some tax basics for different business entities.
Logan Graf is a CPA specializing in small business taxes. He owns a virtual CPA firm called The Graf Tax Co. PLLC, which was established in 2020. He also shares his knowledge with small businesses through his social media platforms, especially his YouTube channel.
What are the most common business entities?
The most common entities are sole proprietorships, partnerships, LLCs, C Corporations, and S Corporations. Each of them is taxed differently, and besides federal tax, there are also different state-level taxes. In this video, we’re only addressing taxes on the federal level. Defining the business entity when you start your small business will implicate how it’s taxed, managed, and who is responsible for its debts.
“Defining the business entity when you start your small business will implicate how it’s taxed, managed, and who is responsible for its debts.”
How different business entities are taxed?
1. Sole proprietorship
A sole proprietorship means one person owns the business, which has no formal legal entity with the state. Sole proprietorships are taxed at the personal tax return level and are subject to self-employment tax, and ordinary income tax.
Self-employment tax comes out to 15.3%, not counting the self-employment tax deduction. No separate tax returns are filed for the sole proprietorship.
The sole proprietorship activity will be reported on the personal tax return of the owner.
2. LLCs
LLC stands for limited liability company and is formed by filing documents through the state and not the federal government. We can differentiate between single-member LLCs and multi-member LLCs.
A single-member LLC can be taxed as an S Corporation, C Corporation, or a disregarded entity (which hasn’t elected to become S Corp or C Corp). A single-member LLC, a disregarded entity, is taxed just like a sole proprietorship.
A multi-member LLC can be taxed as a partnership, S Corporation, or C Corporation. By default, it is taxed as a partnership.
3. Partnerships
Partnerships are passthrough entities which means all income or losses are passed down from the business level to the owner level. In most situations, partnership income is subject to self-employment taxes, just like sole proprietorships. In some situations, partnership income may be passive income and not subject to self-employment taxes.
4. S Corporations
S Corporations are also pass-through entities, so the income is passed down from the business level to the owner level. So Corp income is not subject to self-employment tax but it is still subject to ordinary income tax rates and you’ll need to pay yourself a salary which is subject to payroll taxes.
5. C Corporations
C Corporations are not pass-through entities. So the income that is earned by the C Corp is taxed at the business level. The current tax rate for C Corps is 21%.
Any income that is left over can be paid out as dividends to shareholders which is then either taxed at 0%, 15%, or 20%, depending on overall taxable income level. That’s why C Corp income is said to be double taxed -once at the business level and then as dividends.
If you’re not sure how your business should be taxed, it may be worth it to reach out to an accountant who can help with your first steps. After that, everything will be much clearer.
*The purpose of this page is solely to provide information and should not be considered as financial advice
**Melio does not provide legal, tax or accounting advice; you should consult a professional advisor before making any financial decisions.
