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Tax Treatment

Whether or not you incorporate your business, it will be subject to taxes, including, but not necessarily limited to:

  • Income taxes, including federal, state, and possibly local.
  • Payroll taxes, such as Social Security and Medicare.
  • State and local taxes assessed on businesses regardless of their income.
  • Property taxes, if it owns real estate.
  • Sales taxes. While paid by customers, businesses collect them.

The profits of unincorporated businesses frequently are reported on the owner's Federal Form 1040, Schedule C and similar forms for state and local income taxes. If multiple people own the business, each must pay income tax on his (her) share of the profits.

Corporations, on the other hand, file their own tax returns and pay taxes subject to a different scale of tax rates than individuals face. For a tax perspective, the disadvantages of incorporating include:

  • at lower levels of income, corporations normally pay more tax than individuals
  • dividends are subject to "double taxation." Corporations cannot deduct dividends from their income, yet individuals pay tax on dividends. The owners of an unincorporated business, on the other hand, pay tax on its earnings only once.

If incorporating a small business seems attractive from the standpoint of managing liability (see our discussion of incorporating), but disadvantageous from a tax standpoint, a hybrid solution is available. Frequently referred to as a Subchapter S Corporation (after a section of the federal tax code), this corporate form available for small businesses offers:

  • The limits on liability provided by corporations.
  • Income that "flows through" to the owners' individual tax returns, as if the business were unincorporated. Income thus is taxed only once. Withdrawals of funds from the business are not double-taxed as dividends.

A simplified (from a reporting standpoint) version of the S Corporation is the LLC.

State and local governments hit small businesses with various nuisance fees and taxes. Some even charge businesses with taxes simply for existing, even if they earn no profit. This may take the form of a minimum income tax, regardless of actual income, or it may be a separate levy. These taxes may differ based on whether the business is incorporated.

In all cases, seek the guidance of a qualified tax advisor, such as a Certified Public Accountant or a tax attorney. If you have not already considered it, you may want to make one of these professionals a part of your back ofice staff.
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