The United States has experienced so much economic success because it was founded on principles that allow people to open and run a business in a free market. There are many wonderful aspects that come with operating your own small business. However, owning a business also makes filing taxes more complicated.
What is a sole proprietorship? What is a business partnership? Are they the same thing? How are filing taxes for sole proprietorships and partnerships different from ordinary taxpayers?
In this article, we will answer all of the above and get you prepared for your next tax season.
Types of Business Entities
Sole proprietorships and partnerships are types of legal business entities. They are fancy ways of saying how a small business is classified and structured in the eyes of the IRS.
● Sole Proprietorships: A sole proprietorship is a type of enterprise owned and managed by one individual. There is no legal distinction between the owner and the business entity.
● Partnerships: A business partnership is different from a sole proprietorship because there is more than one owner. However, partnerships are also not considered corporations.
While sole proprietorships and partnerships are technically different entities, they are treated similarly when it comes to filing taxes. Let’s examine the ways taxes are different for sole proprietorships and partnerships.
#1 Taxes are Generally Lower
Sole proprietorships are popular because they are the quickest and simplest way to establish a new business. The business structure enables individual small business owners to avoid registration fees related to creating an LLC or corporation. The legal fees are also less.
As a result, start up costs, including what you will expect to pay in taxes each year, are generally lower. Although not always, many owners avoid some of the stiff penalties and stipulations corporations are required to deal with regarding the IRS.
#2 Tax Returns are Easier to Complete
One of the greatest benefits of sole proprietorships and partnerships is that they are considered “pass-through” tax entities. The term is very important when it comes to filing taxes.
A “pass-through” entity means all profits and losses from the business are passed directly to the business owner(s). It means owners don’t have to file separate returns for business and personal income.
Instead, all owners need to do is report business income on a personal tax return. It ultimately saves a ton of time and money that larger business structures are unable to avoid.
#3 No Double Taxation
Corporations typically face larger tax bills because they have to deal with double taxation. Meanwhile, sole proprietorships and partnerships are able to pass income directly to the owner(s) without having taxes charged to the business.
While small and medium businesses (SMBs) must still report business income on personal tax returns (and pay the appropriate income tax), it does avoid double taxation because they don’t have to file business returns.
Corporations are unable to avoid double taxation. First, they must pay taxes based on business earnings. Then, after profits are distributed to owners, the individual owners must pay income tax on their own individual distributions from profit sharing.
#4 Advantages with Deductions
Tax credits and deductions are a small business owner’s best friends. For example, sole proprietorships and partnerships are allowed to deduct premiums for medical insurance coverage. It may seem like a minor detail, but the deduction can potentially help sole proprietorships and partnerships save hundreds of dollars.
Everyone knows the cost of medical coverage is rising quickly. In addition to health insurance, sole proprietorships and partnerships can deduct dental insurance and long-term care insurance on personal returns. It is a nice feature that allows small businesses the opportunity to offer health insurance to employees while also receiving a nice tax break from the IRS.
#5 Self-Employment Taxes & Estimated Taxes Still Exist
While there are many advantages to creating a new sole proprietorship or business partnership, there are some disadvantages too. Sometimes, businesses are required to pay a mandatory self-employment tax and sole proprietorships and partnerships may need to pay the IRS estimated quarterly taxes if the business is earning an income. It’s important to stay on top of self-employment taxes and estimated taxes in order to remain in good standing with the IRS.
Do you need help with your new sole proprietorship or business partnership? Levy & Associates has decades of experience working with small business entities. We can introduce you to all the tax breaks offered to a sole proprietorship or partnership so you can keep more money in your business.
Contact us today for more information at 800-TAX-LEVY or www.www.levytaxhelp.com. We offer a completely free, no obligation initial consultation. Find out if we are the right fit for your new small business.