Answers to 3 Tax Questions Every Entrepreneur Will Ask
The content on this page is provided for informational purposes only and is not intended as tax or accounting advice that is appropriate for your specific situation. Please consult your tax advisor for guidance on whether these general principles may apply to your specific situation.
If you are like most entrepreneurs trying to start a business, you’ve likely experienced anxiety around how to report and pay your taxes. But don’t fret, the basics are easy to understand–and once you understand them, everything becomes easier.
THE TWO PRIMARY WAYS BUSINESS AND THEIR OWNERS ARE TAXED
Most businesses are classified as “pass-through” entities. This includes sole proprietors, partnerships, most LLCs, and even some corporations. This means the business itself doesn’t pay income taxes. Rather, the income is passed-through to the owners and each owner will report his or her share of the profit on their personal income tax filing (using a Schedule C or IRS Form K-1). Each owner will then pay income taxes based on their share of the business’ profit.
Conversely, if you form a corporation then you’ll be subject to “double-taxation” (unless you make an S-Corp election). This means the business will pay income taxes on its profits and, if it distributes any of the remaining profits to its shareholders, those shareholders will pay income taxes on those distributions.
WHAT MOST NEW BUSINESSES DO
In most cases (but not all), you’ll want to start out as a “pass-through” entity. You can operate as a sole proprietor or you can form an LLC. Single-owner LLCs will usually be taxed as sole proprietors and multi-owner LLCs will usually be taxed as a partnership. In both cases, the company won’t pay income taxes because the profits will “pass-through” to the entrepreneurs that started the business.
HOW TO REPORT AND PAY YOUR TAXES
Now that you have a basic understanding of how the IRS will likely tax your new business, we’ll cover how to report and pay taxes for “pass-through” entities.
In both cases, you need to keep track of your income and expenses throughout the year so that you can complete these next steps. Also, although your tax filing is due annually, you still need to pay estimated taxes quarterly. You should speak to an accountant to set that up.
- Solo-Founders: If you are a sole proprietor or run a single-owner LLC, then you’ll need to complete a Schedule C at the end of each year. The business won’t file that with the IRS but rather, you’ll attach it to your personal income tax filing and will owe taxes on that income.
- Co-Founders: If you create a partnership or a multi-owner LLC and don’t make a different tax election, then the business will need to file an informational tax return with the IRS each year. The purpose of this filing is to let the IRS know how much profit each owner will report on his or her personal tax filing. Then, the business needs to give each owner a K-1 that he or she can attach to their personal tax filing so that they can pay taxes on that income.
NEED MORE INFORMATION?
Entrepreneurs across the country use the Kauffman Foundation’s FastTrac program to help them organize their business plan, figure out how to start their business, and more.
You can learn more and sign up for free at www.fasttrac.org.
Contributor: Chris Brown, Founder, Venture Legal