Would you rather pay taxes on the same income once or twice?
I am going to make a wild guess that 99.9% of you do not want to pay any more taxes than necessary, so you would prefer not to pay taxes on the same income twice.
If you read my one of my previous posts, What is a Corporation?, you know that the biggest downside to structuring your business as a corporation is that it is subject to double taxation. You also know that there are benefits to structuring your business as a corporation that may make it worthwhile to you to be subjected to double taxation. In this blog post, I will attempt to give you a more thorough understanding of what double taxation means so that you can make an informed decision.
Being subject to double taxation means that income earned by a corporation is taxed at the corporate level and then again when it is distributed to the shareholders.
To better understand what this means, lets look at an example. For purposes of this example, lets say that both the corporate and individual tax rate is 15%, there are no state taxes, and there are no personal deductions, exemptions, or credits (or anything that really allows for tax planning).
Alex is the sole shareholder of ABC Inc. In 2015, ABC Inc. earns a net profit of $100,000. Because ABC Inc. is a corporation, it has to pay $15,000 in federal taxes. This leaves ABC. Inc. $85,000 which it distributes to Alex. Alex then has to recognize that $85,000 as dividend income and pay $12,750 more taxes on it. This leaves Alex with only $72,250 of the original $100,000.
On the other hand, what if ABC Inc. was not subject to corporate taxes but instead all of its income flowed through to Alex? In that case, Alex would pay $15,000 in federal taxes and be left with $85,000 instead of only $72,250.
A major reason why many business owners decide to structure their businesses as S-corporations, partnerships, or limited liability companies (LLCs) is that these can be taxed as "flow through" entities. That means that the income flows through the business entity and is only taxed at the owner level. There are restrictions and other drawbacks to these "flow through" entities that will be discussed in future blog posts, but the single level of taxation is a benefit that should not be ignored when you decide on what type of entity is right for your business.
If you have any questions about how various types of business entities are taxes, please feel free to send me an e-mail.
To better understand what this means, lets look at an example. For purposes of this example, lets say that both the corporate and individual tax rate is 15%, there are no state taxes, and there are no personal deductions, exemptions, or credits (or anything that really allows for tax planning).
Alex is the sole shareholder of ABC Inc. In 2015, ABC Inc. earns a net profit of $100,000. Because ABC Inc. is a corporation, it has to pay $15,000 in federal taxes. This leaves ABC. Inc. $85,000 which it distributes to Alex. Alex then has to recognize that $85,000 as dividend income and pay $12,750 more taxes on it. This leaves Alex with only $72,250 of the original $100,000.
On the other hand, what if ABC Inc. was not subject to corporate taxes but instead all of its income flowed through to Alex? In that case, Alex would pay $15,000 in federal taxes and be left with $85,000 instead of only $72,250.
A major reason why many business owners decide to structure their businesses as S-corporations, partnerships, or limited liability companies (LLCs) is that these can be taxed as "flow through" entities. That means that the income flows through the business entity and is only taxed at the owner level. There are restrictions and other drawbacks to these "flow through" entities that will be discussed in future blog posts, but the single level of taxation is a benefit that should not be ignored when you decide on what type of entity is right for your business.
If you have any questions about how various types of business entities are taxes, please feel free to send me an e-mail.
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