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Fletcher: The tax structure and how it relates to businesses

October 30, 2012
Stephen Fletcher , The Alpena News

I've been on a "structure" kick lately. I've been writing about the structure of local governments, businesses and families. Today I'm going to focus on income taxes, as an understanding of tax structure helps a person to be knowledgeable about the current class division controversy in the presidential campaign.

Taxing millionaires and billionaires sounds great in concept, and should be done, but not at percentages greater than what most people pay. When that happens, there are economic consequences, and it is those consequences we need to consider here. But first, let's try to understand the general classifications of business.

There are five basic types of business organizational structures.

The sole proprietorship is a small business with a few employees and owned by a single person. All of the income after expenses flows to the single individual and he/she pays personal income tax on the profit.

It's the same kind of taxation as is used by simple partnerships where the income flows to each partner in a proportion equal to each partner's ownership. Each partner pays tax at the personal level and the partnership doesn't pay income taxes.

Limited Liability Corporations are really partnerships which have incorporated and are taxed only at the personal level, just like the partnerships, with no corporate taxes being paid.

There is a variation of the LLC that is a much older structure called a "Sub-chapter S Corporation" which pays no corporate taxes. All of the earnings accrue to the shareholders and personal taxes are paid at the personal level only.

Larger enterprises are often "C Corporations" and their taxes are paid at the corporate level and if they pay dividends, the dividends are taxed at the personal level. If they make money and don't distribute dividends, then there is no personal tax due because the shareholders received no income.

Unlike all the rest of the organizations, if a C Corporation has a loss, then the shareholders may not deduct the loss on their personal tax returns. If any of the rest of the described companies lose money in a year, then the partners or shareholders may deduct the losses from their personal taxes.

What a business does determines how it is categorized. Barber shops, real estate office, or other service-oriented businesses can be categorized in anything but a C Corp., as they have little need for additional capital after their establishment. As profits are made they just flow to the owners and not much, if any, money is retained by the business. Remember, if money is retained by a proprietorship, partnership, LLC, or sub-S corporation, then the owners pay tax on that money even though they didn't receive it.

In the case of the C-Corp, the money retained by the corporation has been taxed at the corporate level only, and personal taxes aren't paid until a dividend is actually received.

Next Week: Taxes, the economy and the real problem that needs addressed.



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