Tax Implications of a New Tax ID Number

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When you get a tax ID number, your business is now officially recognized by the Internal Revenue Service. Business formation is a vital component economic growth and development. The business tax code provides entrepreneurs with an incentive to create new business through special tax deductions and credits. On the flip side, no matter how a business is registered, it must pay taxes to the government.

Business Formation

In the United States, a new business can file as a sole proprietorship, partnership, limited-liability company or corporation (S or C). Each one has it pros and cons. Talk to an accountant regarding the tax implications for your elected business status. To obtain a business tax ID or an Employer Identification Number (EIN), a business selects an operating structure amongst the four choices for business formation that will determine its tax treatment with the IRS. An EIN works similar to your personal Social Security number. The process of obtaining an EIN is simple and takes just a few minutes. As a registered business, you must file and pay taxes to the IRS. Your business can be subject to fines and penalties if it does not file and pay its taxes on a timely basis.

Sole Proprietorship

If you filed for an EIN as sole proprietorship, you must set aside enough money to pay taxes on business income earned throughout the year. In order to accomplish this, you will have to make quarterly estimated income taxes to the IRS. In addition, you must make Social Security and Medicare tax payments, referred to as "self-employment taxes". The self-employment tax rate is 15.3 percent of the first $106,800 (12.4 percent for Social Security tax plus 2.9 percent Medicare tax). In contrast, an employer splits Social Security and Medicare taxes with its employees, having only to pay 7.65 percent. Sole proprietors report self-employment taxes on Schedule SE along with a 1040 income tax return and Schedule C.

Partnership

Unlike a corporation, the IRS does not consider partnerships as separate from their owners for tax purposes. The partnership is a “pass-through” tax entity. Income and losses pass along to the partners who pay taxes on their distributive share in the partnership. A partner must make tax payments to the IRS each quarter based on his estimated tax liability. A partnership must file Form 1065 to the IRS; this form shares information about whether the partners are reporting their income correctly. Partners must also submit a Schedule K-1 which shows each partner's share of profits and losses. Similar to a sole proprietorship, a partner must pay his own self-employment tax.

Limited-Liability Company

The IRS treats a limited-liability company (LLC) as a sole proprietorship or partnership depending on the number of members in the LLC. Single-owner LLCs pay taxes as sole proprietorship, and multiple-owner LLCs pay taxes as partnerships. The operating agreement details each member’s distributive share of the LLC’s profits and losses. For example, if there are four LLC members, their respective share in the profits and losses of the LLC is 25 percent. A "special allocation" distribution is when a member’s allocation is not proportionate to his ownership interest. Like a partnership, a multi-owner LLC must file Form 1065 and Schedule K-1. Members are responsible to pay the 15.3 percent self-employment tax.

Corporations

A corporation is recognized as a legal entity separate from its owners. The company pays taxes on all income that it cannot deduct as business expenses must file a corporate tax return using Form 1120. However, a corporation and its shareholders are subject to double taxation. The company pays taxes at the corporate level, and shareholders pays taxes on dividend distributions. Shareholders who are employees of the corporation must pay individual income taxes on their salaries and bonuses. The corporation does not pay taxes on salaries and bonuses because these are deductible business expenses. However, a corporation is responsible for withholding the proper payroll taxes from its employee’s paychecks and submits its portion of Social Security and Medicare tax payments along with its employees to the IRS and state government. An S corporation unlike a C corporation described above is taxed differently. An S corporation can be taxed as a partnership or LLC.

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