Important: To all SCORE mentors and clients – This Brief incorporates important 2018 Tax Law revisions to the taxation of the legal forms of organizing a small business. Both new and existing businesses should seek professional advice when evaluating the complex decisions required to establish, and perhaps change, their business’ legal form.
IRS Form SS-4: All businesses must register with the IRS to obtain an Employer Identification Number (EIN). This number is necessary to set-up a business bank account and will be used on all tax filings, both business income and payroll tax reports.
Sole Proprietor Single Member LLC with Business Income and/or Expenses (with or without employees)
Business Income and Expenses: The income of the business is calculated on Schedule C or Schedule C-EZ (a service business with less than $5,000 in expenses) and reported on the sole proprietor’s or single member's personal income tax return, on Form 1040, Line 12.
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Link to instructions.
Self-Employment Income: A sole proprietor or LLC single member is not an employee of the business. All proprietorship or LLC income (guaranteed payments, distributions and retained earnings/member basis) is taxed at the 2019 federal self-employment rate (for 2019) of 15.3% (12.4% of the first $128,400, for Social Security and 2.9% for Medicare, no dollar limit). This tax is calculated on Schedule SE and then reported as “other taxes” on Form 1040, Line 14. An employer-equivalent offset rate, the 50% employer portion, is calculated on Schedule SE and then deducted on each member's Form 1040, Line 27.
Multiple Member LLC with Business Income and/or Expenses (with or without employees)
Business Income and Expenses: The business’ financial data, including the balance sheet if gross receipts are more than $250,000, is reported on Form 1065, Return of Partnership Income
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Each member’s pro rata share of business income (guaranteed payments, cash distributions, and share of LLC income, deductions and credits) is recorded on Schedule K-1 and reported on the appropriate line of each member’s personal income tax return, Form 1040.
Self-Employment Income: LLC multiple member are not employees of the business. All LLC income (guaranteed payments, distributions and retained earnings/member basis) is taxed at the 2019 federal self-employment rate of 15.3% (12.4% of the first $128,400, for Social Security and 2.9% for Medicare, no dollar limit). This self-employment income is reported on Schedule K-1, calculated on Schedule SE and then reported as “other taxes” on Form 1040, Line 14. An employer-equivalent offset rate, the 50% employer portion, is calculated on Schedule SE and then deducted on each member's Form 1040, Line 27.
Sub-Chapter S Corporation
Business Income and Expenses: An LLC can be elect, on IRS form 2553, to be taxed as an sub-S corporation (while remaining an LLC) so the LLC members can be paid as company employees. The taxable business income of an S corporation, after paying reasonable salaries to owners, is:
- not subject to self-employment taxes – a major tax savings for a growing small business
- taxed directly to the shareholders
- not subject to a double (corporate) tax on business income
Shareholders can still receive corporate dividends that are tax-free, if the distributions do not exceed their stock basis. If an annual distribution exceeds the shareholder's year-end stock basis, the excess amount is taxed as capital gains.
The business’ financial data, is reported on Form 1120S, Return for an S Corporation
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Each shareholder’s pro rata share of business income (cash distributions, and member's share of sub-S income, deductions and credits) is recorded on Schedule K-1 and reported on the appropriate line of each shareholder’s personal income tax return, Form 1040.
Federal Estimated Income Tax
Sole proprietors, LLC member and sub-S shareholders must make estimated tax payments if, when filing their annual return, they will owe $1,000 or more in self-employment and business income tax. These estimates are paid quarterly on Form 1040-ES.
Qualified Business Income Deduction - NEW
Effective with the 2018 tax year, pass-through business owners (sole proprietors, LLCs and S corporations) receive a deduction of 20% of their taxable business income. To qualify for the full deduction, the owner’s taxable income cannot exceed $157,500 (filing as a single) or $315,000 (filing jointly). The deduction is limited above these amounts and phased out for all personal service business owners (lawyers, doctors, accountants, wealth advisors, business consultants).
Regular Corporation - NEW
Effective with the 2018 tax year, all taxable corporate income is taxed at a 21% flat rate, down from a top marginal tax rate of 35%. So, small businesses should give fresh consideration to setting up their start-up or converting their existing business to the corporate form. While distributions are taxed again, at the personal level, if income needs to be retained for expansion (to buy fixed assets, add employees or working capital), this may be an effective tax strategy.
Taxpayers with Employees
IRS Publications 15 - Employer’s Tax Guide: This is the essential guide to calculating, withholding, depositing and reporting federal taxes that apply to the employees of businesses. A table lists the tax forms and tax filing due dates.
Federal Deposit Form 8109 is used to make bank deposits of withheld/employer-paid Federal income taxes, Social Security, Medicare and Unemployment taxes. Employment Forms: W-4 is required from each employee to determine number of personal exemptions when calculating Federal income tax withheld. I-9 is required from each employee to verify U. S. citizenship.
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