Understanding Your business tax obligations

Anyone earning income in the U.S. must pay taxes to the federal, state, and local government. Taxes depend on a lot of factors including whether you are filing as a single or married person, the amount you earn per year, and where you reside in Georgia. Usually, the simpler your business structure is the simpler your tax requirements may be. Please note that this guide is not intended to provide tax advice. Business owners are encouraged to seek tax advice from a qualified tax professional.

Protecting Your personal finances

A business can exist separately from its owner. Similar to a person, businesses can then enter into agreements or contracts, obtain credit, incur debts, engage in lawsuits, and be held accountable for its actions.

When your business is recognized as a separate legal entity, meaning that the business is separate for its owner, you can benefit from limited personal liability. This generally means that your liability for the business’s debts is limited to your personal investment in the business. For example, if someone sues the business, they generally cannot go after the owner’s personal belongings, like their house or car, to settle the lawsuit.

What is a sole proprietorship?

A sole proprietorship is a type of business structure that is easy to form and gives you a complete control of your business. You may already be a sole proprietor if you have provided goods or services without filing any paperwork with the government. You report business income on your personal tax return, so tax preparation is relatively easy.

Sole proprietorships do not produce a separate business entity. This means your business assets and liabilities are not separate from your personal assets and liabilities. You can be held personally liable for the debts and obligations of the business. Under this business structure, it may be harder to raise money because you cannot sell stock and traditional lenders (like banks) are hesitant to lend to sole proprietorships.

Sole proprietorships can be a good choice for low-risk businesses and owners who want to test their business idea before forming a more formal business.

What is a General Partnership?

A general partnership works well for two or more business owners who are looking to share financial liability or risk and make business decisions together. Like a sole proprietorship, there is little to no paperwork if you have engaged in business activities with another person and held yourselves as partners in business. Personal assets are not protected in a general partnership, and the personal assets of one partner can be at risk as a result of poor-decision-making by any partners.

It is highly recommended that partners develop a partnership agreement. A partnership agreement is an important document that states what each partners’ rights and responsibilities are with regards to the business.

Most partnership agreements answer the following questions:

• How much is each partner investing?

• What are the responsibilities of each partner?

• How will the partners make decisions?

• How will the partners share profits and losses?

• How will the partners resolve conflicts?

• What happens when a partner decides to leave the business or sells their interest in the business?

What is a Limited Partnership?

A limited partnership is composed of general partners and limited partners. A general partner operates the same way as an owner who has a sole proprietorship or general partnership in that they manage the business of the limited partnership, make deals, make decisions, and act on behalf of the partnership. In most cases, a limited partner is a passive investor, meaning they invest money and receive their portion of the profits, but cannot manage the day to day operations or act on behalf of the partnership. Unlike general partners, the personal assets of a limited partner are protected. The limited partners’ liability is limited to the money invested into the business.

Unlike limited partnerships in many other states, in Georgia limited partners may participate in controlling the business without becoming personally liable for the limited partnership’s obligations.

The limited partnership pays no entity-level income tax or net worth tax. You report business income on your personal income tax return, unless the limited partnership elects to be taxable as a corporation.

What is a Limited liability Company (LLC)?

The limited liability company (LLC) offers limited liability or lower personal financial risk, a big advantage over the sole proprietorship and partnership structures. Under the law, the business is a separate legal entity from the business owner(s) and all of the owner(s) obtain protection of their personal assets. Articles of organization required and an operating agreement is highly recommended.

In order to maintain an LLC, owners should open a separate bank account for the LLC, invest a sufficient amount in the LLC for its own expenses, not mix their personal assets with business assets, and not use LLC funds for personal expenses. Owners, known as members in an LLC, can choose to manage the business themselves or designate managers to run the business. Managers are considered employees and as a result would have to have work authorization.

The members of an LLC can choose how the LLC will be taxed when it is formed. Unless a filing is made with the IRS electing to have the LLC taxes like a corporation, owners will likely report business income on their personal tax returns.

What is a corporation?

A corporation is usually used for large businesses with many owners because it offers the ability to issue shares. A share represents an ownership interest in the corporation. Forming a corporation requires a significant amount of paperwork and has significant ongoing costs and legal requirements.

A corporation is composed of three different “players”: the shareholders, directors, and officers. Shareholders own the corporation and elect the directors. The directors govern the general affairs of the corporation and appoint officers who conduct the day to day business of the corporation. It is common in smaller corporations for an individual to hold two or three “player” positions, meaning one person can be the sole shareholder, director, and officer. A corporation may not be an ideal business structure for an entrepreneur starting up a small business.

Limited liability is one of the most important reasons to incorporate. The debts incurred by the corporation cannot generally be collected from the officers, directors, or shareholders. This allows one to protect his or her personal assets from the debts and obligations of the corporation. Corporations are subject to “double taxation” unless it is filed with the IRS as a “S Corp”.