| How Businesses Are Taxed | Businesses have to pay federal income tax just like individuals. However, different business entities are taxed differently. Understanding these basic differences will help you to identify federal income tax obligations as you conduct business with different business formations. Income taxation can impact commercial transactions between different kinds of businesses, such as sole proprietorships, partnerships, franchised, and corporations. Sole proprietorships
A sole proprietorship is a small business owned by a single individual. The owner is the business; the business is not a separate legal entity. The federal income tax obligation to be aware of when conducting business with sole proprietorships is that the sole proprietorship pays income tax only once on the income of the business, which the owner reports on his personal income tax form. There is no separate tax-filing requirement for the business itself. Since the sole proprietor is the business, he is responsible for the same income tax obligations as are most individuals. He does get the benefit of all business deductions, which he can write off against his personal income. In a good year, the owner of a sole proprietorship may want to make capital purchases, and defer payments from creditors until after the end of the tax year, so that he can offset assets and liabilities against his tax burden. Partnerships
In a partnership, two or more people agree to combine their money, ideas, skills, and efforts and then share the resulting successes or failures. A partnership itself doesn't pay taxes, but it does file an informational tax return with the Internal Revenue Service. The partners show their parts of the income or losses and business deductions of the partnership on their respective personal income tax returns, and each pays taxes on that portion. The income tax obligation of limited partners doesn't exceed their original contribution and they cannot deduct its losses from their income. Limited partners only contribute money or make other valuable financial contributions to a partnership. They don't take part in the management of the enterprise. When conducting business with partnerships, bear in mind that they may be looking for business expenses to write off against their personal income. Also, they may want payments to fall at specific times. A partnership may invest in capital equipment at year-end so that the asset can be divided amongst the partners to offset against each of their personal income tax burdens. Likewise, they may carry liabilities over to the following year. Franchises
A franchise is made up of a franchisor and one or more franchisees. A franchisor grants a license to use its name, product, and procedures to a smaller company, a franchisee. The franchisee pays a licensing fee to the franchisor. Federal income tax obligations for franchises are based on their business structure. A franchise can be set up as a sole proprietorship, a partnership, or a corporation and, as such, are taxed accordingly. Corporations
A corporation is its own legal entity and is owned by its shareholders. Corporations are taxed on the income of the corporation. But in the case of corporations, there is double taxation. Not only do corporations pay tax on their income, the shareholders pay tax on their dividend income. S corporations are the exception. They are taxed like partnerships and, as such, there is no double taxation. These are known as "pass-through" entities. The taxable income is passed through and is taxed only at the shareholder level. S corporations are small, privately held corporations limited to 35 shareholders. Corporations may deduct business expenses against their income. The ending of a corporation's financial year may mean they want all deliveries made and payments received before the year ends to increase their income. However, this will increase their tax bill. A corporation may make capital purchases at the end of a financial year so that money is spent that would otherwise be taxed, and assets are gained to be written off against a tax burden. A corporation may defer debt payments until the next financial year so the liability can be written off against the year's income. Tax laws change all the time, so if you have concerns about the tax implications of any commercial transactions, always consult your tax advisor prior to doing business with other business entities. As a manager, you will want to possess a solid understanding of the federal income tax obligations to take into account when conducting business with sole proprietorships, partnerships, franchises, and corporations. Understanding these basic differences in the ways businesses are taxed is an important step in building strong working relationships with a variety of different businesses. | Course: American Business Formations of the 21st Century
Topic: Taxation Issues and Commercial Transactions | SkillSoft Corporation, Copyright 2002. All brand or product names and their content mentioned in this product are the property, trademark, service mark, or registered trademark of their respective holders. |