Double Taxation Of Small Business Profits: How To Avoid It

Double Taxation Of Small Business Profits

Have you thought about formally incorporating your existing small business or self-employment endeavor? There are a great number of benefits!

To begin, you and your family will have better protection against the risk of a lawsuit that might put an end to your business. When you establish a corporation, you move from a world in which you have unlimited liability to one in which you have limited liability. This is the first step on the route known as “Asset Protection.”

Regarding taxes, incorporating a business can positively and negatively affect your finances. Yes, starting a corporation has the potential to either lower or raise the amount of taxes you owe, depending on the kind of corporation you decide to establish.

There are primarily two kinds of corporations: “C” Corporations and “S” Corporations. When it comes to taxes, selecting the right kind of corporation for your business might make all the difference.

NOTE: The subject of whether your company should be a “C” or “S” corporation has no bearing on the fact that your corporation will protect your assets. This is not a legal problem; it is a tax problem.

If you have a “C” Corporation, you run the risk of falling into a tax trap known as “double taxation.” Yes, the revenue from a “C” Corporation can be taxed twice: first, when it is earned at the corporation’s level, and again when it is distributed to you, the shareholder, in the form of dividends.

Double taxation can be avoided in different ways. Notifying the Internal Revenue Service of your decision to operate as an “S” Corp rather than a “C” is frequently the most straightforward course of action.

The profits of an “S” Corporation are not taxable to the corporation; instead, these profits are reported directly on the personal income tax return of the shareholder and are consequently taxed only once. S-Corporations are pass-through entities.

And that’s enough for now, don’t you agree?

It goes without saying that any piece on the topic of Choice of Entity needs to include the age-old caveat, “Consult your tax professional”; nonetheless, I will not recommend a solution to this problem that applies to everyone.

But the “S” Corporation is a fantastic fit for many people who own small businesses or are self-employed since it offers protection from personal liability and avoids the unpleasant tax trap of double taxation. These are two significant benefits that are worth checking into.

Suppose you choose to incorporate your sole proprietorship and later determine that the “S” Corporation is the best option for your business needs. In that case, you are obligated to notify the Internal Revenue Service (IRS) that your corporation will be electing “S” Corporation status by submitting Form 2553, which is, in essence, an application to become an “S” Corporation.

IMPORTANT

The Internal Revenue Service will automatically classify your company as a “C” corporation if you incorporate but fail to file Form 2553. To put it another way, all you have to do to become a “C” Corporation is incorporate.

Be sure to read the instructions for Form 2553 very carefully, or consult a tax professional, since there are crucial filing guidelines and deadlines that must be followed.

Your corporation’s application to become an “S” Corp will be denied if Form 2553 is not filed on time or if it is filed incorrectly, and the corporation will be treated as a “C” Corp by default. This will put the corporation in the position of being subject to double taxation, precisely the situation you were hoping to avoid.

Please visit the IRS website here to obtain a copy of Form 2553.

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