What Role Do Tax Considerations Play in Business Formation?

Talking about tax is rarely any fun, but if you own a business it is a necessary evil, and understanding tax considerations for your organisation is vital. Business tax is by no means “one size fits all” and factors like location, structures and operations can have a massive impact on how much you need to fork out to the taxman.



Because of this, it's really important to familiarise yourself with your tax responsibilities in order to avoid any nasty surprises, save money and ensure compliance and we’re going to be looking at some of these key factors in this article.

When It Comes To Tax, Your Business Model Matters

The amount of tax you pay can vary significantly depending on the type of business entity you have as each business model has its own rules for taxation, which directly impact how much you owe and your filing obligations.

But before you decide to hit the button on your new business, make sure you choose the right kind of business model for your situation.  Here are some of the different models to think about:

• Sole Proprietorships usually involve one business owner (who, incidentally, will find they’re overloaded!) They need to report all income and expenses through personal tax returns. And then they’ll be responsible for paying self-employment taxes based on their returns.
• Partnerships pass profits and losses to partners' individual tax returns based on ownership shares.
• Corporations are big companies which are a legal entity separate and distinct from their owners - which means that they have their own legal rights and obligations. Corporations face double taxation since earnings are taxed at the corporate level and then again when distributed as dividends.
• S-Corporations avoid double taxation as income and losses are passed to shareholders - but they do but have strict eligibility requirements regarding shareholders.
• Limited Liability Companies (LLCs) offer flexibility by choosing between partnership or corporate tax treatment.

Choosing your business model does, of course, involve more than just tax. Your choice will also impact on things like liability protection and administrative requirements and so it’s important to choose wisely; and seek professional help if necessary.

How Income Splitting Can Cut Your Tax Bill

In some instances, partnerships and S-corporations will allow for something known as income splitting. In basic terms, this involves dividing income among owners or family members in lower tax brackets as a way of reducing tax payments. An example of this might be a business owner who pays himself a modest salary in order to maintain profits as dividends which helps to avoid higher personal tax rates.

This can be an extremely beneficial way of keeping money within the business - particularly with family owned businesses who can leverage this by employing relatives at fair wages. You do, however, need to be careful here as failing to manage this properly might result in the taxman (HMRC or IRS) sniffing around if foul play is suspected. Because of this, your first priority is to always ensure compliance to avoid penalties and maximise savings.

Why You Need To Know Your Place When It Comes To Tax

We’ve talked about choosing what type of business you’re going to be setting up - and where you set it up is equally important in terms of tax obligations. Corporate taxes including income, sales and liability can differ greatly from country to country and even from city to city and so it’s important to do your research to find the best fit for your business.



You’ll also want to check out any incentives such as credits for investing in infrastructure or hiring local employees. An example of this would be Florida, USA where, if you choose to form an LLC, you’ll need to draft an LLC operating agreement in Florida to outline ownership and responsibilities, while adhering to specific state laws, including legalities concerning local taxes.

It’s never a smart idea to make assumptions when it comes to taxes and so you’ll really need to do your homework to find out what the rules are in any given location to make sure that you’re getting the best deal possible.

Your Responsibilities As An Employer

To get your business up and running there’s a good chance that you’re going to need some help in the form of employees - and these bring with them their own set of tax responsibilities. Depending on where your business is, you can expect to find yourself facing a whole ‘nother set of tax considerations including PAYE, insurance, contractors vs full time staff and even tax on employee benefits such as  Medicare.



Failing to comply with these responsibilities can result in major headaches and, in some cases, a hefty fine. As you can imagine, a lot of companies find it helpful to work with professionals to ensure compliance.

A Local Tax For Local People

But just when you thought things couldn’t get any trickier, along comes sales tax! As the name suggests, this kicks in when your business is selling something in the form of a product or service. Sales tax isn’t, however, created equal as, depending on the nature of your company, you may also face local taxes and / or need a seller’s permit. On the other hand, you may also be pleasantly surprised to find that part of your business is exempt from tax - for example if you’re involved in food production or educational activities. You may also find that there are different rules if your business operates online as well as through a physical outlet such as a high street store.



When starting a new business, your first port of call should always be to check out government schemes and incentives as these can really help you minimise your tax payments and keep your profits where they belong.

Where To Begin With Start-Up Costs And Tax Deductions

When triggering a new startup, it’s important to know that some expenses can be tax deductible literally from your first day of trading. Again, the type of expenses you can claim on may differ from country to country - as will the amount that you can deduct in your first year so it’s your responsibility to research this valuable benefit. Always make sure that you track all eligible expenses from day one to make sure that you maximise savings and have tangible proof of your expenses should the taxman come calling.

Conclusion

Tax can very much be a, well, taxing subject but it’s also a super-important one. Failing to comply with local, national and even international tax rules can not only land you in trouble with the law but can also damage the reputation of your business (nobody wants to feature in THAT headline!). You can usually find guidance on your business taxes but to ensure compliance you’re almost always better off investing in the services of a professional as this will usually save you time, money and hassle in the long run.