One of the least understood aspects of being a small business owner is related to pay and income taxes. Often, this is due to not knowing the IRS rules surrounding the structure of the business.
The IRS considers all entities except a C-Corp as a pass-through entity, which means the income passes through to the owners/shareholders.
Each state looks at this differently. Some tax the business, some tax the owner.
Here’s a brief overview of some of the major tax implications related to payroll & taxes on your business...
Entity Type / Taxable Item | How Taxes are Paid | Sole Proprietor | LLC Taxed as Sole Proprietor or Partnership | LLC Taxed as S-Corp | S-Corp | C-Corp |
|---|---|---|---|---|---|---|
Salary Paid Through Payroll | Taken Out Through Payroll | Not Permitted | Not Permitted | Generally Required & Must be Reasonable | Generally Required & Must be Reasonable | Generally Required |
Guaranteed Payments | Paid by Shareholder | Not Permitted | Permitted Only if Allowed by Operating Agreement | Not Permitted | Not Permitted | Not Permitted |
| | | | | | |
Distributions / Draws | None | Permitted but Optional | Permitted but Optional | Permitted but Optional | Permitted but Optional | Not Permitted |
Dividends | Paid by Shareholder | Not Permitted | Not Permitted | Not Permitted | Not Permitted | Yes |
| | | | | | |
Net Income of Business - Paid by Shareholder | Paid by Shareholder | Yes | Yes | Yes | Yes | No |
Net Income of Business - Paid by Business | Paid by Business | No | No | No | No | Yes |
Social Security & Medicare Taxes | | Paid by Owner on Tax Return | Paid by Owner on Tax Return | Salary has taxes paid through payroll. Shareholder pays taxes on net income of business | Salary has taxes paid through payroll. Shareholder pays taxes on net income of business | Salary has taxes paid through payroll & business. |
| | | | | | |
IRS Income Tax Return Filed | | Schedule C | Schedule C or 1065 | 1120S | 1120S | 1120 |
Taxes aren’t the only consideration for what type of entity is best for you. Still confused? Or, not sure how to set aside the money you need for taxes? Reach out to us today to see if we can help!
