Getting Ahead of Taxes for 2021 and Beyond
Since it is assumed that you are not here doing some light reading for entertainment, you must be looking for some help or insight into the IRS and tax system as pertaining to your business. There is some great information here, and you will likely find some of value that will save you some money in taxes. You may have arrived here through an Internet search, so thanks. However, keep the pitfalls of the Web and taking the advice of non-professionals you may meet.
Often the new or growing small business or single entrepreneur owner/operator will be watching their pennies while they grow their business. Using the Web and talking to others may become the only way in which business tax information is learned. Consider, even though this information is reliable, that the advice of an accountant or other tax professional could save you not only time but lots of money over the next year or longer.
What business entity should I use?
While most solopreneurs start out as sole proprietors, they may find that another business entity formation would be better for long-term growth. What are the choicesi?
- Sole Proprietorship – As a sole proprietor, you and the business are one and the same as far as legal and financial matters. Any claims, creditor, or court actions against the business can and will go after your personal assets as well. For this reason, it may be easier for you to get business credit if your personal credit is good but understand the risk. The tax responsibilities for the business are passed along to the owner and filed with a Schedule C with their personal tax return.
The sole proprietorship is the easiest business entity to set up and operate, so it does appeal to new business owners. As a sole proprietor, you also have complete control over the business and decision-making. You must be extra careful to keep your business and personal income and expenses separated.
- General Partnership – When you think of a general partnership, think of a coming together of multiple sole proprietorships. That is because the general partners, unless agreed otherwise, all can make business decisions, and contract on behalf of the business. It is easy and inexpensive to start and manage. What comes with this structure is complete sharing of liability as well. The partners all are liable for debts or other business obligations. Responsibility for taxes is passed along to the partners through a Schedule K-1, and the partners then file a Form 1040 and a Schedule E.
- Limited Partnership – In this partnership structure, there are two types of partners:
- General Partners – Think of these as the owners in a general partnership, making the decisions, managing the company, and sharing the liabilities as well.
- Limited Partners – These are partners who serve as investors, funding the company but not participating in ownership decisions or management. They usually do not share the liabilities, so their risks are low to encourage their investment. Taxes for the Limited Partnership are generally handled the same as for the General Partnership.
- Limited Liability Company (LLC) – The LLC is a combination of the best features of a partnership and a corporation. The owners manage the business like a partnership, but the LLC structure is a totally separate legal entity. This isolates the assets of the owners (members) from the business operations. Obligations of the business, debts, or judgements are enforceable only against the LLC.
Tax responsibilities for the LLC are more complicated. Depending on the formation details and setup, the LLC and members can be taxed as a sole proprietorship (sole owner LLC), partnership, corporation, or S corporation.
- Corporation – The full corporation is a legal entity entirely separate from its shareholders. It protects the assets of the shareholders, as they have no liability for any actions against or obligations of the corporation. They are more expensive to start and require more details in management and reporting. They are double-taxed, in that the corporation is taxed on its profits, and then the shareholders are taxed individually on their personal returns for money they receive.
- S-Corporation – If a corporation meets the IRS requirements and is properly formed, it enjoys the protections of the corporation, but is not double-taxed. Distributions to shareholders are taxed once at the personal level.
Looking forward, getting the right entity structure for your business is important, and the earlier the better. Get some advice, as it becomes more complicated later to change entities.
Are They an Employee or an Independent Contractor?
After COVID-19 arrived, the importance of knowing the difference between an employee and an independent contractor from the IRS’ perspective has become critical. More and more businesses are either sending workers home to work, hiring subcontracted or freelance labor, or doing both. Many businesses found that they maintained productivity with home workers while cutting their costs for office space. Others decided to begin using freelancers or subcontractors instead of employees to also save on employee benefit costs.
It is critical that you understand how the IRS classifies the two worker types, and their tests to identify a valid independent contractor from an employee. It has to do with things like the amount of control you have over their work, instructions, and materials you provide, and other factorsii.
The Long-term Plan for Tax Advantages
You no doubt have put a lot of thought, time, and effort into your business plan and future success. Devote a fraction of that thought, time, and effort into a taxation management long-term plan for 2021 and beyond to increase profits, lower taxes, and plan for your retirement.
Consider spending a few bucks now to save major bucks down the road by consulting with a tax team to pull your plan together. They can help you to properly form your business, set up accounting to save time and money, and put tax advantaged practices into play for the future.
i Business Structure 101, Squareup.com
ii Independent Contractor (Self-Employed) or Employee, IRS.gov