Companies of all sizes and industries were literally put under pressure in 2020. Nobody could have predicted the consequences of the corona virus for entrepreneurs from independent contractors to C companies and everyone in between. <! – ->
However, it is positive that the tax period has been postponed to July 15, 2020.
Company structure tax comparison for 2020
That said, there is still time to learn about tax issues based on your business unit and to take advantage of some tax savings regardless of your legal structure.
Sole proprietorship <! – ->
In a sole proprietorship there is no legal separation between the business owner and the company. Property and liabilities are held on behalf of the owner. Usually the owner is an individual, but it can also be a married couple. Company taxes are submitted as personal income using Schedule C (company profit or loss) filed with IRS Form 1040.
Although it is the simplest and cheapest type of business that needs to be founded and maintained, there is a disadvantage that the owner is personally legally and financially liable for the company. For example, if the company is affected by a lawsuit or the company is unable to pay its debts, the personal assets of the owner (bank accounts, apartment, car, pension, etc.) are at risk.
In most countries, starting a sole proprietorship can be as easy as submitting a fictional name, also known as a DBA (Doing Business As). But even that may not be necessary if the owner uses his first and last name in the company name. Depending on the type and location of the company, licenses or permits may be required. Otherwise, the formalities for start and ongoing compliance are minimal.
A sole proprietorship is usually sufficient for: <! – ->
- Domestic companies
- A business with only one owner
- Companies without employees
- A company that offers products and services with minimal legal risks.
Company income is subject to self-employment tax. Entrepreneurs of individual companies were therefore entitled to funding through the CARES law from both the Paycheck Protection Program (PPP) and the Economic Injury Disaster Loan (EIDL) and EIDL Advance. According to the PPP and EIDL advance rules, the business owner would not have to repay or repay the PPP as long as 75 percent of the proceeds are used to replace income and the other 25 percent are used to qualify business expenses. However, since the PPP application required 2.5 months' worth of income documentation, some independent contractors may not have enough expenditure to be considered forgivable. This means that the remaining amount must be repaid at a fixed interest rate of 1.00%. The balance of the PPP loan is due in two years and payments are deferred by six months. The good news is that business loan interest is deductible as long as the money is used for business purposes.
Although the self-employed are normally not entitled to unemployment benefits, they are entitled to the special program Pandemic Unemployment Assistance (PUA) under the CARES Act if they are qualified. How much PUA pays varies by state, as does regular state unemployment insurance (UI) programs, which are funded by the federal government. Taxes on PUA payments can be withheld on request. (S Corps and LLCs are also entitled to PUA benefits.)
<! – -> Another option for taxpayers who claim loss of business on their individual income: due to the coronavirus crisis previous restrictions on individual business loss deductions ($ 500,000 for couples and $ 250,000 for other applicants were suspended for the period 2018-2020.
In its simplest form, the partnership structure reflects an individual company. It is used when there is more than one owner of the company. In a partnership, the owners share the legal, financial and management responsibilities for the company. In fact, one partner's actions could make another partner's personal assets liable.
Partners should have a detailed partnership agreement with their lawyer to determine the division of property and duties. As with a sole proprietorship, there is no separation between the company and its owners. Trade tax obligations are transferred to the individual owners.
There are other types of partnerships, including:
- Limited Partnerships : A partnership in which some or all of the partners have limited partnerships.
- Professional partnerships : The unit consists of two or more professionals such as accountants, doctors or lawyers who provide the public with professional services.
- Limited partnerships : A partnership with a general partner (runs the business and is personally liable for the debts and obligations of the business) and a limited partner (limited partnership and does not participate in the management).
A partnership is usually sufficient for:
- Business partners who do not intend to reinvest money in the business
- Company with several owners without employees
- Multi-owner company that offers minimal legal risk products and services
Unless there is a special agreement between the partners, the IRS considers all partners to be the same when assessing tax obligations. You are taxed equally in a partnership, regardless of whether you are a partner who contributed financial assets or nothing.
In contrast to sole proprietorships and partnerships, a C Corp. a legal entity separate from its owners – all actions of the company belong only to the company. Owners are employees, and therefore C Corp offers its owners (shareholders) a significant degree of personal liability protection. The ability to sell shares in the company provides the ability to raise capital to fund initiatives and drive growth. The status as a C corporation often makes a company more attractive to external investors.
A company must submit its own income tax return (IRS Form 1120) and can deduct business expenses, which reduces its tax liability when it generates revenue. Dividends paid to shareholders are deemed to be income for shareholders and must be claimed on their shareholders' individual tax forms. The term "double taxation" is often used to describe how a company's earnings are taxed, and then profits that are distributed as dividends (which are not deductible as expenses for the company) are taxed to shareholders.
Establishing a company involves submitting statutes to the state and involves higher start-up costs and higher administrative complexity than running a company as a sole proprietorship, partnership or LLC. A company must have statutes and a board of directors, hold regular meetings, and comply with other regulations to maintain its status.
The advantages of a C Corp are:
- The company is a separate legal identity.
- There is limited liability for the owners
- Business is ongoing
- There are no restrictions on who can hold shares
- Easily transferable shares
- to prefer venture capitalists and other investors
- Possibility to offer stock options
The Law on Tax Reductions and Employment from 2017 reduced the corporate tax rate from 35 percent to a flat rate of 21 percent. However, the law also removed deductions for maintenance costs and transportation services for workers, such as local passports, commuter vehicles, and parking permits.
The CARES 2020 law introduced some tax benefits that C Corp owners can take advantage of, including:
NOL (Net Operating Loss) transfers . The CARES Act temporarily lifted the NOL exclusion that was removed under the 2017 Tax Cut and Employment Act. The net operating losses that occurred in 2018, 2019 and 2020 can now be traced back up to five years. In addition, the taxable income limit of 80 percent for the use of NOL for the years 2018 to 2020 has been lifted.
Extended interest deduction . The 2017 tax cuts and jobs law limited the deduction that companies could claim for interest on corporate debt to 30 percent of adjusted taxable income (ATI). The CARES law limits net interest depreciation to 50 percent for 2019 and 2020.
Charitable Donation . C Corps may deduct a charity donation, but only up to 10 percent of its taxable annual income. According to the CARES law, the C Corps can temporarily use up to 25 percent for cash donations in 2020. In addition, donations for food stocks were increased from 15 percent to 25 percent.
S Corp is a subtype of the corporate structure. It enables a C-company to choose taxation as a partnership, with all business income being taxed at the owner (shareholder) level at the tax rate for natural persons. This avoids the double taxation that companies normally face. A possible tax advantage for owners is that instead of the entire business income, only the salaries of the owners are collected. Profits granted to shareholders as distributions are not.
Some other advantages of a C Corp, such as personal liability protection, are retained. On the other hand, for an S Corp. a number of restrictions on ownership of shares. For example, it can only issue one share class, it can only have up to 100 shareholders, and it cannot have shareholders who are non-residents.
Today, the IRS allows several types of companies to be taxed as S Corp. For example, an LLC, just like a company, could be taxed as an S Corp if it applied for the election of S Corp the required time period.
S Corp is preferable if:
- C Corp shareholders or LLC members want to minimize their tax burden for the self-employed
- The company wants to avoid double taxation of dividend income.
- A company need not issue more than one share class or have more than 100 shareholders.
Again, the main advantage of S Corp's election status is that only the income paid on the payroll is subject to the self-employment tax. Profits paid as distributions / dividends are not subject to social security and Medicare tax.
Limited Liability Company (LLC)
The LLC structure combines the advantages of a company with those of a partnership or a sole proprietorship. It can be a single member LLC or a multiple member LLC. An LLC is considered a separate entity from its members, so it offers some liability protection to its owners. In general, LLC members' personal assets are not at risk if the company is sued or unable to pay its debts.
In an LLC, members can choose how their business divides the company's profits and losses among its owners. This enables members to consider not only the money invested, but also the time and effort involved in distributing profits. The LLC is a pass-through unit, like a sole proprietorship and a partnership, in which all income flows to the members and is shown in their personal tax returns. However, the LLC can also choose to be taxed as a C Corp or S Corp.
The LLC structure also offers management flexibility. It can be managed by members, with the owners performing the day-to-day administration. Or an LLC can refer to a person (or people) as a manager, which is referred to as an LLC managed by managers. Most states view an LLC as "member-managed" by default, unless the founding documents state that it is an LLC managed by managers. Learn more about the options of Member-Managed LLC and Manager-Managed LLC.
The LLC structure is preferable if:
- Entrepreneurs want limited personal liability, but not a company's compliance formalities.
- Entrepreneurs want flexibility who owns and manages their company.
- The company does not plan to apply for venture capital and equity.
LLC business profits that are passed on to individual members are subject to Social Security and Medicare tax. This can lead to an unfavorable financial situation for LLC owners as they have to pay self-employment taxes on their distribution share of the LLC's profit even if they invest that money back in the business rather than distributing these profits.
CARES Act Tax Changes for Employers
Deferral of income tax . Companies with employees are entitled to late wage tax payments according to the CARES law. This means that the company can postpone the company's share in social security tax on workers' wages from March 27 to December 31, 2020. As an employer, you must pay half of the deferred amount by December 31, 2021 and December 31, 2021, the other half by December 31, 2022. Self-employed workers can also defer half of the self-employment tax they owe. However, employers who have received a PPP loan cannot postpone the deposit and payment of the employer's contribution to the social security tax once the company has been informed that the PPP loan has been granted.
tax credit for employee retention . If a company had to completely or partially shut down operations in a quarter of 2020 due to the pandemic, the company is entitled to the tax credit for employee retention . The company is also eligible if the gross income has decreased significantly. Again, a company cannot claim the employee retention tax credit if the company has received PPP funding. The credit corresponds to 50 percent of employee wages from March 12, 2020 and before January 1, 2021, but the self-employed are not entitled to this tax credit. According to the IRS, authorized employers can then use the funds to pay wages to receive the employee retention loan. A company can either use the money saved for wages or request an advance on the loan from the IRS for the amount of the loan that is not funded through access to federal labor tax deposits by submitting Form 7200, Prepaid by employer credit based on COVID-19 .
Families First Coronavirus Relief Act (FFCRA) . With effect from April 2, 2020 to December 31, 2020, FFCRA will expand FMLA services and offer companies reimbursement of paid sick leave due to the coronavirus. Employers must pay paid sick leave if:
- The employee has to quarantine or isolate himself due to the corona virus.
- An employee has coronavirus symptoms and is waiting for a diagnosis.
- The employee is a caregiver for a person (does not have to be a family member) who has to be quarantined or isolated himself.
- An employee looks after his child because his school or childcare is closed.
- Employers then receive a refundable tax credit equal to 100 percent of the family vacation wages paid . The FFCRA also applies to the self-employed.