One major step in the process of setting up a business is figuring out your tax obligations. Although the regulatory framework is fairly similar across the United States, this can be a complex matter as different types of businesses may have different requirements. The registration process and tax obligations may also vary from state to state and even from one city to another.
Sales Taxes and Exemptions
If you are a seller of tangible goods, chances are you are required to pay sales tax. The rate may vary from one state to another, with Delaware, Montana, Oregon, New Hampshire, and Alaska having a 0 percent sales tax. You may be looking at a tax of anywhere from 3 percent to 12 percent in other states. However, if you are conducting a resale business and buying stock for resale purposes only, you can apply for a sales tax exemption certificate.
These certificates allow you to avoid paying tax on the products you buy purely for resale. Every resale business should be applying for, and using, these certificates to avoid paying taxes that you are not obliged to pay. The US Department of State has compiled guides to apply for these sales tax exemptions or resale certificates in each state and territory.
Make sure you familiarize yourself with all the requirements as well as the process for registering and using a sales tax exemption certificate in your state. It is advisable you consult an attorney, chamber of commerce, a business advisor, or your local revenue authority to confirm you are fully compliant with all laws and regulations.
Depending on the state you’re applying in, you may be asked about the structure of your business and its ownership (sole proprietor, partnership, LLC, etc).
If your business is a corporation or an LLC, you may also need to provide your incorporation date, corporation number, and Federal Employer Identification Number.
You should only work with suppliers that allow you to supply your sales tax certificate, so you can avoid paying taxes you are not obligated to pay as a reseller of goods.
Exemption certificates should be used only if you are buying merchandise with the sole intention of reselling it. Misusing or abusing tax exemption certificates could lead to fines and legal problems.
Your business tax requirements may also depend on the scale of the business you operate and the type of legal entity you operate as. Setting up a legal entity enables you to legally operate as a business, pay the right taxes and organize liability.
Any of the business types we mention in this article can take advantage of a 20% pass-through deduction. This means you can deduct up to 20% of your business profits from your personal tax return. Anybody that is classed as an employee of the business, and receives a wage, does not qualify for this deduction. You can learn more about this complex tax deduction here.
There are a few business types and entities that are most commonly used by small businesses and companies just starting up. These are:
Liability and Taxes
|Sole Proprietorship||One person||Unlimited personal liability||Personal tax|
|Partnerships||Two or more people||Unlimited personal liability unless structured as a limited partnership||
|Limited Liability Company (LLC)||One or more people||Owners are not personally liable||
A sole proprietorship is the simplest of all the business entity types. As a sole proprietor, you are setting up a business with a single employee - yourself. The business income is treated as your personal income. However, this means you are fully responsible for the business and all its liabilities. In other words, you will be personally liable for all the debts and obligations of your business. You have the option to register the business under a name different from your personal name.
A sole proprietorship is considered the best option for business owners who are just starting and want to test the waters, with less paperwork and costs involved. The Small Business Association recommends businesses with lower risk start up as a sole proprietorship (unless you are working with partners), as they are easy to form and gives you full control over your business. One possible downside is that banks and other financial institutions are more reluctant to finance a sole proprietor unless you are able to put up significant assets, such as your own home, as collateral, should you require funding.
Limited Partnerships and Limited Liability Partnerships
If you plan to run a business with one or more partners the most popular choices are limited partnerships (LP) and limited liability partnerships (LLP).
In the LP structure, one general partner has unlimited liability while other partners have limited liability but also limited control over the business. The advantage of this structure is that it gives the founding member more control over the business, even as additional partners (for example, investors) are added to the business. The primary partner carries personal responsibility, but also cannot lose control of the business to other partners. The obligations are often determined and defined through a partnership agreement. Taxes are reported through personal tax returns, while the general partner (usually acting as the boss) is also required to pay self-employment taxes.
The running of the business will be in the hands of the general partner. This means that new limited partners can be added as the business grows, and in order to add capital, without changing the governance of the company.
The LLP provides limited liability to each member of the ownership structure. Each partner is protected from the debts of the business and is protected from liabilities resulting from the actions of other partners. However, every partner will have a say on how the business is run, even if they join the company later. An LLP is also taxed through personal taxes in the same way as a Limited Partnership, only there is no lead partner paying self-employment taxes.
Limited Liability Company (LLC)
A Limited Liability Company is a structure that provides protection from personal liability should the business go bankrupt or hit any other sort of a legal or financial roadblock.
As an LLC member, you are considered a self-employed person and are required to cover your self-employment tax contributions towards Medicare and Social Security. You can also report profits and losses through personal tax returns without facing corporate taxes.
LLCs are complex business structures that have a variety of tax options available. These options vary depending on whether you are dealing with a one-owner LLC or a multi-owner LLC. A one-owner LLC is dealt with by the IRS as a sole proprietorship. The LLC itself does not pay taxes, but the owner will need to declare profits on their tax return.
Multi-owner LLCs are treated as partnerships by the IRS. Instead of paying business taxes, LLC owners pay for profits in their personal income tax. However, an informational tax return is submitted to the IRS, which will then review it to ensure that partners are declaring their incomes correctly.
Multi-owner LLCs also have the option to be treated as corporations for taxation purposes. You will need to file IRS form 8832 and check the corporate tax treatment box. This is particularly advantageous if you need to retain a large amount of the profits in the LLC (as opposed to distributing it to partners). You might want to choose this option since the corporate tax rate is lower than the top three individual income tax rates, and you will also benefit from tax-advantaged fringe benefits.
As LLC partners are not considered employees of the company, they are required to pay self-employment taxes. Some states do charge additional taxes and fees to LLC, so be sure to consult your state authorities, lawyer or accountant.
An issue with the LLC business structure is the fact that its life may depend on the ownership structure. What this actually means is that, depending on the state, if a member leaves an LLC, it may face dissolution and a transformation into a different legal structure. However, these instances can be regulated by an agreement between the business owners.
If you are looking to start operating on a mid-to large scale, an LLC could be the right fit for you, especially if you want to keep some personal assets separate from the business.