Well, as the New Year approaches, one may decide to go into business for himself/herself, and as discussed before, there are the three major types of formations of a business, the sole proprietorship, the partnership, and the corporation. What was not discussed before, was how each of these business structures are taxed. Note if you require more information contact your accountant.

First, the sole proprietorship, as discussed before, is the simplest formation, with hardly any paper work, just start to operate it. However, the tax consequence is that not only the sole proprietor will be taxed on his/her net profits, but also the “self-employment tax” will be triggered, which is the “two-sides” of Social Security and Medicare taxes, because a sole-proprietor is both an employee and an employer for Social Security and Medicare tax purposes.

Secondly, there is the partnership, which is again, an association of two or more individuals (or businesses) to carry on as co-owners a business for profit. However, the way a partnership is taxed, is not on the partnership itself, but on each individual partner. In other words, the proportionate share of a partner’s net profits of the partnership is “flow-through” or “pass-through” the individual partner, and yes the partner’s proportionate share of net profits will be taxes for both income tax and self-employment tax purposes. However, the partner will retain a”basis” in the partnership, in case the partnership suffers losses for a given year, or the partner wants to withdraw some some money (or any other asset) from the partnership.

Finally, is the corporation, which is a legal separate and distinct entity from its owners and/or shareholders. Thusly, being a distinct and separate entity, it is usually taxed on its own net profits, and any dividends being distributed out to its shareholders (which is usually from the same net profits), will be taxed again on the shareholders. Hence, the corporation would be subject to this “double taxation” feature. However, the corporation can elect itself out if this “double taxation” regime, being a “S corporation”, which is also a “flow-through” or a “pass-through” entity, similar to a partnership.

So, if you are planning to start a new business for yourself and want to do some tax planning on your business, then contact us at [email protected], and we would be more than happy to assist you on the tax consequences of your business formation.