08 Feb Early Stage: Step 6 – Taxes, taxes, taxes!
Editor’s note: This is the sixth in a series of articles on developing start-up companies in the technology or biotechnology sectors. The most recent article focused on forming a business entity.
Madison, Wis. – Now you have formed an entity. As part of the decision as to the type of entity to use, you should have concerned yourself with taxes.
The income tax is the tax most people think of first. Income taxes depend upon the type of entity you form. If the entity is a C-corporation, the entity itself pays the income taxes. Income tax rates progress starting at 15 percent on the first $50,000 of taxable income and rising to 38 percent on over $15 million in taxable income.
Income from “flow-through entities” such as partnerships and S-corporations are included in the income tax returns of the owners of the entities, usually based on each owner’s percentage of ownership in the entity. Flow-through entities, themselves, do not pay income taxes.
Individual income tax rates depend upon whether you are a married taxpayer filing jointly, single, and so forth. Most of us are familiar with these income tax tables because we pay them personally. Most LLCs with more than one member are taxed as partnerships.
Obviously, income taxes can be very complicated. The previous comments are just the tip of the iceberg. How entities compute their taxable income is beyond this article’s scope.
Employment taxes are usually the next tax in terms of taxpayer importance. IRS Circular E (Publication 15) provides guidance on an employer’s tax responsibilities at the federal level, and the Wisconsin Employer’s Withholding Tax Guide, last revised in February 2004, covers an employer’s obligations at the state level. Circular E is available on the IRS website, and the Wisconsin Employer’s Withholding Tax Guide is available on the Wisconsin Department of Revenue website.
Social Security taxes are assessed against the wages of the employees of an entity. Whether a person is an employee or an independent contractor is a tricky question. (I will cover who is an employee in a subsequent column.) Generally, the more control the entity has over how, when, and where work is completed, the more likely the person is to be an employee. Both the employer and employee pay 7.65 percent of their taxable income in Social Security taxes on the first $97,500 in income (for 2007), for a combined total of 15.3 percent.
After $97,500, the employer and employee each pay 1.45 percent on all earnings, for a combined total of 2.9 percent. The $97,500 figure is increased each year for inflation.
Partners in a partnership, including members of an LLC taxed as a partnership, are not considered employees for Social Security purposes. Instead, they pay self-employment tax on their share of the profits of the partnership or LLC. The rates are the same as for employees, except the employee pays both the employer’s share and the employee’s share (i.e., in 2007, 15.3 percent on the first $97,500 in income, and 2.9 percent thereafter).
Shareholders of an S-corporation are treated differently. They do not pay self-employment taxes on their share of the corporation’s income. Shareholders that provide services to an S-corporation must receive “reasonable compensation” from the corporation, on which Social Security tax is assessed just like any other employee as described above.
If a shareholder does not draw a salary for services provided (or does not draw a large enough one), the IRS will, under certain circumstances, recharacterize a portion of the shareholder’s share profits in the corporation as wages. This is done so that Social Security taxes can be assessed on it.
Both the federal government and the State of Wisconsin assess unemployment taxes. The federal unemployment tax is 6.2 percent of the first $7,000 of an employee’s wages, but a credit is given for a portion of the tax that is paid to the state.
Workers’ compensation is technically not an employment tax, although most employers feel that it is because they have to pay it on each and every corporate employee. Workers’ compensation, which was pioneered in Wisconsin, is insurance that provides a guaranteed payout to injured workers. In exchange, the employees lose their ability to sue the employer for workplace injuries, with certain exceptions. The Department of Workforce Development administers Wisconsin’s workers’ compensation insurance.
Sole proprietors, partners, and members of an LLC are not considered employees for workers’ compensation purposes, but may elect to be covered by it. Up to two corporate officers and ten shareholders may elect not to be covered by workers’ compensation by filing a form with the Department of Workforce Development.
Tax on your sales
Finally, all entities should be concerned about sales taxes. Generally in Wisconsin, all sales of tangible personal property and some services are subject to the sales tax. The state rate is five percent, and counties may assess up to .5 percent.
Entities are also subject to use tax. Use tax is essentially a sales tax charged on taxable items used or consumed in Wisconsin on which sales tax has not been paid. For example, if your entity purchased a computer over the Internet on which it did not pay sales tax, the entity would be liable for use tax on the purchase price.
Previous articles by Joe Boucher
• Joe Boucher: Early Stage: Step 5 – Forming the entity
• Joe Boucher: Early Stage, Step 4: Cautionary trademark tales
• Joe Boucher: Early Stage, Step 3: Naming the entity
• Joe Boucher: Early Stage Step 2: Choosing a domain name
• Joe Boucher: Starting a tech business? Step 1 is minding the intellectual property
• Joe Boucher: Madison is flourishing while Marinette is dying
The opinions expressed herein or statements made in the above column are solely those of the author, and do not necessarily reflect the views of Wisconsin Technology Network, LLC.
WTN, LLC accepts no legal liability or responsibility for any claims made or opinions expressed herein.