Even though the weather outside your window is likely frigid, it’s not too early to start thinking about taxes and April 15. For example, two major tax changes will impact small business owners as they complete their tax returns this spring.
Meanwhile, according to Michala Irons, an associate with Barnes & Thornburg LLP in Indianapolis whose background includes a stint with the IRS Office of Chief Counsel in Washington, DC, the tax liability of a company (and its owners) is dependent on how it is organized. She also notes the way a business is organized as of the first day of its tax year controls its status for how it will pay taxes for the year.
Two tax changes to look out for...
According to Irons, two major tax changes went into effect January 1, 2013. Both are newly created taxes that will impact taxpayers for the first time this April.
One, the Net Investment Income Tax, is a 3.8% tax on investment income. It applies only to individuals, estates, and trusts with income above certain thresholds The second is a 0.9% increase in Medicare taxes, also for individuals with wages, compensation, and self-employment income above certain thresholds.
The new taxes are imposed on the owners of a C-corp, an S-Corp or an LLC, meaning they aren’t being imposed on businesses but the owners themselves.
“These additional taxes were enacted as part of the Affordable Care Act,” says Irons. She advises small business owners to familiarize themselves with them to ensure they are compliant.
Want to be an LLC?
Irons advises small business owners to consider their goals for their new enterprise when determining how to organize their venture. For example, those seeking “a lot of flexibility in terms of management and control” might favor an LLC, also known as a Limited Liability Company. That’s because in most states, an LLC can be managed by either its members or a manager who needn’t be a member.
It’s important to note under the Internal Revenue Code (IRC), a multi-member LLC is taxed like a partnership under Federal law and usually even under state law.
“Under Federal law, members of an LLC can decide to be taxed as a partnership,” even if they elect an LLC form under state law, says Irons. The major benefit is that the business entity is not taxed, although the individual is, eliminating the concern of double taxation.
C-corp. vs. S-corp?
Taxation is usually considered the most significant difference for small business owners when determining whether to establish an S or C corporation.
For example, the IRC treats a C corp as a separately taxable entity. That means it files a corporate tax return and pays taxes at the corporate level. Meanwhile, double taxation is possible if corporate income is distributed to business owners as dividends, because then it’s considered personal income. Double taxation occurs because taxes on corporate income are paid first at the corporate level and then again at the individual level on the dividends.
Although it has been in existence for quite some time, the subchapter S corporation has been gaining popularity, partly because it is a hybrid of an LLC and a C-corp, says Irons.
Just as with the LLC, individual members pay taxes on their profits on their personal tax returns. However, unlike a C corp, an S-corp generally does not pay corporate taxes.
“People who don’t want or need to make special allocations prefer the simplicity of how income flows to owners,” in an S-corp, says Irons.
Restrictions on who can be a C, an S or an LLC
The IRC defines what is necessary for an entity to qualify as an S corp. According to Irons, qualifications of an S-corp include:
Can have between one to 100 shareholders
Generally, individuals must be the shareholders
No nonresident aliens can be shareholders
The corporation must have a single class of stock
Meanwhile, in some states an LLC can also be owned by just one person. However, if there is only one owner, they can elect to be taxed as a disregarded entity (like a sole proprietor) or as a corporation, says Irons.
By: Tami Kamin Meyer Tami Kamin Meyer is an Ohio attorney also licensed in both of Ohio's federal districts as well as the U.S. Supreme Court. In addition, she is an oft-published freelance writer whose byline has appeared in Better Homes and Gardens, The Rotarian, Corporate Secretary, Legal Newsline, Ohio Magazine and Columbus Monthly, to name a few.