Just like any business owner, it is a domain investor’s goal to have more money coming in than the amount of money coming out. It does not stop from just purchasing domains. Other expenses incur in maintaining your business. There are the payments for software, salaries to pay your team, utilities, marketing projects, etc. Most importantly, there are taxes you need to settle.
In this article, we will be discussing the different types of business structures and their tax implications. This is to help you to determine the proper structure for your domain investing business concerning tax strategies.
The types of business structures include sole proprietorship, partnership, limited liability partnership or LLP, limited liability company or LLC, corporation, and nonprofit. A nonprofit business involves charitable missions or community development, although nontaxable, we will not be discussing this type of business formation since it is not relevant to a domain investing business.
So let us begin by identifying the different types of structures that apply to a domain investing business.
Types of Business Structures for Domain Investing
1. Sole proprietorship
Definition
The simplest type of business structure is sole proprietorship. It is often used by solo entrepreneurs who want full control of their company. A sole proprietorship considers the and your business to be one. Since you own the business by yourself, all the earnings go to you, but so do all the liabilities, losses, and debts. It means that when your business cannot cover these debts, your personal assets and accounts can be looked into.
Tax Implication
As discussed above, you are not personally separated from your domain business. You are your company. That is why in a sole proprietorship, your business does not owe the government taxes. It is you who must settle the taxes, not your company.
When you file your personal tax return you must declare your self-employment earnings and your business earnings using Schedule C. However, you can also file for a 20% deduction of qualified business income (QBI) in your Form 1040. QBI is basically your business income. You are qualified for this deduction if your total taxable income is $182,100 or lower.
Seeing that you are self-employed, you may also take advantage of the 100% deduction on your health insurance, given that you are not under any other health plan from another employer.
2. Partnership
Definition
This is a business structure where 2 or more people joined together to build the business. Income, liabilities, and debts are distributed to partners depending on the agreed percentage of ownership.
Similar to sole proprietorship, income is considered to be “passed through.” This means that the company is not responsible for paying taxes. The settlement of taxes is passed through to you and your partners.
Tax Implication
Filing a tax return in partnership is similar to a sole proprietorship. Each partner is required to include the percentage of the business income they earn in their personal tax returns using Form 1040.
You can also be eligible for the QBI and health insurance tax deductions. However, partnerships must file a Schedule K1 form to declare the share of income, deductions, credits, etc.
3. Limited Liability Partnership (LLP)
Definition
Limited liability partnership is a type of partnership where a partner is not personally liable for any negligent act or error caused by another partner. Although all partners are directly involved and can manage the business, your liability extends to just the amount of your investment in the business. Creditors cannot access your personal accounts and assets in case of unpaid debts.
Tax Implication
LLP is also considered a “pass-through” entity. Business income is passed through the personal tax returns of the partners. Schedule K1 is also used for the declaration of the share in income and expenses.
Although some states do not allow LLPs to apply pass-through taxation. It is best to check your state’s regulations, as some states also require franchise tax to be paid by LLPs.
4. Limited Liability Company (LLC)
Definition
As per irs.gov, a limited liability company “is a business structure allowed by state statute.” Regulations in LLCs may vary in each state. For this reason, if you are thinking of having an LLC, it is advisable that you check your state’s regulations with regard to LLCs.
Most states require you to file an annual report or a statement of information (SOI). This is one of their requirements for maintaining your LLC classification. In LLC, owners like yourself are referred to as members. A limited liability company may include an individual, partners, or even corporations as its members.
As the name implies, members of an LLC have limited liability in the business, meaning, you are also not personally liable for incurred debts. Limited liability companies can either be classified or treated as sole proprietorships, partnerships, or corporations, depending on the election made.
Compared to LLP, which separates you from another partner’s mistakes, LLC members can be held liable for another member’s negligence.
Tax Implication
An LLC with only one owner is treated as a “disregarded entity.” This entails you pay income taxes through your personal tax return. No business tax is paid.
While the business is classified as a sole proprietorship for tax purposes, you are not personally liable for the company’s debts. A business with two or more members is likewise treated as a partnership in taxation unless elected to be a corporation.
An LLC partnership is an extended version of an LLC sole proprietorship where members are also not personally liable for the company’s debts. Form 8832 is used for filing if LLCs want to be elected as a corporation.
5. Corporation
Definition
A corporation is a business structure that is a company or a group of shareholders that is authorized by law to act as a single entity. This means that shareholders have limited liability for business losses and debts.
Owners are considered to be separate entities from the company itself. It can be said that a corporation can be treated as an individual unit that can enter transactions, borrow money, or pay taxes under its name. Corporations are state elected, depending on the regulations.
There are 2 classifications of a corporation, the S corporation and the C corporation. They differ mostly in their tax implications.
C Corporation and Its Tax Implication
C corporation is the generic type of corporation. Unlike other business structures, this uses Form 1120. The corporation pays taxes under its name at a rate of 21% of all income. Even so, you still pay the taxes for the after-tax income of your domain investing business, depending on your shares.
This leads to double taxation, where you are taxed for both your domain investing business income and personal income. But C corporations are eligible for federal tax deductions that are not available for other structures. They can deduct all business expenses, such as marketing costs, employee benefits, and other operating expenses. Owners are also treated as employees who receive their payments, which prevents them from paying self-employment tax.
However, your social security and healthcare benefits are subject to FICA (Federal Insurance Contributions Act) tax. The FICA tax rate is 7.65%, which is considerably lower than the self-employment tax rate of 15.3%.
S Corporation and Its Tax Implications
S Corporation allows only up to 100 shareholders. It is considered to be a pass-through entity with limited liabilities. With this type of business, double taxation is avoided.
An S corporation does not pay corporate taxes, the shareholders must pay income tax based on their shares, whether it is distributed or not. But if you choose to write yourself as an employee and take your salary from the profits, you are not subject to self-employment tax.
A portion of your taxes are automatically deducted from your salary and your share of the net business income is considered to be a dividend, which is usually taxed lesser than income.
Conclusion
Depending on the size and goals of your domain investing business, selecting the best business structure for taxes is still up to you, the owner of the business. To protect your personal assets, it may be suitable to choose to have an LLC or an S corporation.
They are considered to be pass-through entities that steer you away from corporate taxes and thus avoid double taxation. You only declare your share of the income for taxation. But there are still other factors that you still need to consider.
Examine the flow of income and your expenses. Determine which deductions you are qualified to avail of. Analyze your numbers and evaluate which business formation would help you generate the most tax savings.
In some cases, domain investors combine structures for tax purposes. Check state regulations if you are considering LLP or LLC. Some states vary in requirements to form these types of business structures. Given the tax implications of these different business forms, it is still best to seek the expertise of a financial or tax advisor.