Legal business structures: Impact on your taxes

When December arrives, I always find myself writing about the beginning of tax season. Now you may think tax season begins in March or April, but experienced business owners realize that any thoughts of finding ways to cut exposure to taxes really needs to begin before the end of the year, and legal business structures are a prime example. TYPES OF LEGAL BUSINESS STRUCTURES

One would need a lawyer to wade through all the definitions of a legal business structure and what's best for you. But for the purposes of this column, let's limit ourselves to four distinct entities that most often apply to small businesses:

- Proprietorship - This is the simplest of legal structures. There is no legal barrier of liability between you, individually, and any lawsuit filed against your business. For income tax purposes, you will file a Schedule C along with Form 1040. After deducting business expenses, the net income is then transferred to Form 1040, where it will be exposed to the limitations and advantages of personal filings.

- C Corporation - This provides a liability buffer between the individual and lawsuits; the IRS is addressing a business entity, not a person. The company files IRS returns on Form 1120. Your personal compensation is directed to your personal filings only, including any dividends you may withdraw from the corporation.

- S Corporation - This is probably the most popular among small businesses, especially in the start-up period. Like with C corporations, liability, in most cases, is limited to the company, not the individual. However, the owner has the option to divert a greater portion of compensation to dividends instead of the salary or wage.

- Limited Liability Company - This is an increasingly popular form of legal business structure. However, its greatest advantage is reduced personal liability for the business owners. Often, the personal liability is limited to the amount of capital invested in the company.

Keep in mind that these are only general definitions of the most common forms of business structures.

TAX ADVANTAGES?

No one individual or company has the exact same set of circumstances regarding income and taxes. Here are three common examples:

- Tax-Deductible Donations - In a proprietorship, donations are not deducted from business income. They are deducted from personal income on Form 1040 only.

-FICA - Exposure can be dramatically reduced in an S corporation, because you are able to direct a greater share of your compensation to dividend distribution, which is not subject to FICA distributions by the company.

- Unemployment Compensation - This is not a required contribution by the sole proprietor who does not designate himself an employee in his company.

In general, a proprietorship will likely provide the least number of tax advantages to the business owner.

GET HELP

The tax obligations, the definitions of legal business structures, filing requirements and costs from one state to the next are so diverse. There is simply no one set of answers for all of us. I strongly recommend that you:

- Visit the IRS Web site at www.irs.gov and begin reviewing all the publications related to legal business structures and their tax obligations.

-Visit your state's Web site at the page where state incorporation is addressed. It will describe obligations and procedures.

- Contact a lawyer who specializes in incorporation. Be prepared to answer a lot of questions about your existing business structure and finances.

It is going to take some time, so you may want to begin this evaluation process now. And don't be surprised if your incorporation application is put on a waiting list for processing in January. End-of-year submittals are very common in all states.

(Stephen Windhaus is a small-business consultant based in Florida. More information and resources about small business and business planning can be viewed at www.windhaus.com. Distributed by Scripps Howard News Service. For more news and information visit www.scrippsnews.com.)

Other Usefull Tax Articles

Most Viewed Articles