Sole Proprietorship, S Corporation, LLC, Corporations… Starting a business can be very confusing. What do these terms mean? What do they mean for you and taxes?
Legal Entities and Tax Structures
Legal Entity: an individual, company, or organization that has legal rights and obligations.
That’s right, you are a legal entity.
If you’re doing business, you may want a separate legal entity that will have its legal obligations and rights; and here are a few reasons why:
Legal entities can enter into contracts on their own behalf, providing you with liability protection.
Legal entities can be owned by more than one person, making them ideal for bringing on partners or investors.
Legal entities have special tax rules and advantages.
Some examples of legal entities are:
Partnership (You and a Friend)
Limited Liability Company (LLC)
Each of these entity types has a specific section of the tax code.
Individuals are taxed as Sole Proprietorships, subject to income and self-employment tax. (Income Tax = Marginal Tax Rates, SE Tax = 15.3%)
Corporations are taxed under Subchapter C by default, sometimes referred to as C-Corp. C-Corps are liable for Corporate income taxes, and the owners (Stockholders) pay tax again when funds are paid out as dividends.
LLCs are a hybrid, sharing similarities with Individuals, Partnerships, and Corporations. An LLC with one member is taxed like an Individual, Sole Proprietorship. LLCs with multiple members are taxed as Partnerships. LLCs also have the ability to elect to be taxed as other entity classes, such as Subchapter C, like a Corporation. There is also a special section for small businesses, Subchapter S.
Subchapter S is the tax code for small businesses and predates the adoption of the LLC entity type. Before LLCs, this Subchapter was used by Corporations, which is the term's origin for entities electing this tax status, S-Corporation (S Corp).
LLCs or Corps that are taxed under Subchapter S, aka S-Corps, are "Pass-Through" entities. Business profit passes through the entity to the owners (Shareholders) and is only taxed as ordinary individual income. Meaning, you no longer have to pay Corporate Income Tax with a Corporation or Self Employment Tax if you have an LLC.
Subchapter S LLCs
When a business elects to be taxed under Subchapter S, there are some requirements. For an LLC to no longer be subject to Self Employment Tax, you must also be an employee of your business. This means putting yourself on the payroll. You will pay yourself a reasonable wage for the work you do; the rest will be business profit. From the business profit, as the owner, you can take money out as a Shareholder Distribution.
Shareholder Distributions can happen as frequently as you like. It is simply the tracked transfer of funds from the business bank account to your personal bank account. This tracking is why having formal bookkeeping and accounting processes are essential!
What is Collective?
Collective.com is an online Tax Accounting service for Freelancers, Consultants, and Solopreneurs.
We specialize in small businesses, specifically Subchapter S LLCs.
To focus on small businesses and not get bogged down with big corporate clients to pay the bills, we offer our services as an all-included membership tailor-made for Businesses-of-One (owner).
Membership with Collective.com includes:
Subchapter S Election
Quickbooks Online Essentials (Bookkeeping)
Registered Agent Service
Membership with Collective is contract-free! You pay month to month with no terms or commitments or you can pay annually. You are the owner of your books, payroll, and tax plan.
Are we the best fit for your business?
To help as many people as possible, we have a pretty narrow area of expertise. If the following applies to you, we are very excited to chat about the next steps!
Are you the only owner of your business?
Are you required to pay Sales or Use Taxes?
Is your small business is your primary source of income?
If the answer is “Yes,” we’re looking forward to chatting with you soon!
An individual, company, or organization that has legal rights and obligations
A single human being as distinct from a group, class, or family
Limited Liability Company (LLC)-
One type of legal entity that can be formed to own and operate a business; created in Wyoming in 1977
A business or firm owned and run by two or more partners.
A company or group of people authorized to act as a single entity (legally a person) and recognized as such in.
The simplest and most common structure chosen to start a business. It is an unincorporated business owned and run by one individual with no distinction between the business and you, the owner.
The S corporation rules are contained in Subchapter S of Chapter 1 of the Internal Revenue Code (sections 1361 through 1379). Congress, acting on the Department of Treasury's suggestion of 1946, created this chapter in 1958 as part of a larger package of miscellaneous tax items
S corporations are Corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.
A structure in which the owners, or shareholders, are taxed separately from the entity
The taxing of profits from the business is at both corporate and personal levels, creating a double taxation situation.
The distribution of some of a company's earnings to a class of its shareholders, as determined by the company's board of directors.
Dividends are payments made by publicly-listed companies as a reward to investors for putting their money into the venture.
Shareholder distributions are the earnings by S corporations that are paid out or "passed through" as dividends to shareholders and only taxed at the shareholder level.
A type of tax that governments impose on income generated by businesses and individuals within their jurisdiction. Income tax is used to fund public services, pay government obligations, and provide goods for citizens.
Self Employment Tax-
A tax imposed on the self-employed for the purpose of funding Social Security and Medicare Benefits