This is an excerpt from a presentation I give to college students and to prospective entrepreneurs about types of business entities.
A college professor (who’s also an attorney) told me that my presentation to her students on this subject was the best, clearest and most-concise overview of the topic that she’s ever heard.
I’m flattered by the compliment, and will try to translate those positives into a series of blog posts.
When a business decides what type of entity it wants to be for tax purposes, it has 4 options:
- Sole proprietor
(What if you’re an LLC? We’ll get that in a future post.)
Before we go further with discussing each of these options, let’s define a few terms that will come up repeatedly in our discussion.
When the term “gross income” is used in a business sense, it means income coming in the door before expenses are accounted for.
Net income refers to what’s left after business expenses are accounted for. If the business spent more than it brought in, then it has suffered a “net loss.”
Another common term for this is “net profit” or “net loss.”
FICA Tax/Self-employment Tax
FICA taxes are Social Security and Medicare taxes. For employees, these taxes are taken out of each paycheck in the amount of 7.65% of the employee’s wages. Behind the scenes, the employer pays a matching 7.65% to the government on the employee’s behalf.
When someone is a sole proprietor or a partner in a partnership, they are considered both employee and employer (for FICA tax purposes only) and owe 15.3% self-employment tax on the net income of the proprietorship (or the partner’s share of the partnership’s net income). This is in addition to the income tax owed on the net income.