-Alicia Sitan (12/5/2020)
When starting a new business venture there are many things to consider, which at times can feel like a very daunting task. Today we are just going to take a quick glimpse at a few of the things to consider when starting a business in Hawaii.
Entity Selection
The type of business you choose will depend on several factors including liability protection, taxation, and record-keeping. Here is a quick look at the different types of entities one can select from when creating their business.
Sole proprietorship (“Sole Prop”) – This is the most common form of business organization. It is easy to form and allows the owner complete managerial control. However, the owner is also personally liable for all financial obligations of the business.
Resource for more information regarding a sole prop entity. https://www.sba.gov/content/sole-proprietorship
Tax Considerations: As a sole prop no additional tax return will need to be filed by the Owner. Instead the business activity will be listed on the Schedule C of an individual’s 1040 tax return. On top of income tax, a sole prop owner will need to pay self-employment tax of about 7.5% in relation to their sole prop net income. Sole prop owners should not pay themselves W-2 wages and should only take draws from the company as a form of compensation.
Partnership – This type of entity involves two or more people who will share profits and losses of the business based upon a partnership agreement. Partnerships are considered “pass through” entities so the profits and losses of the entity will be reported on the partner’s individual tax return. There are various types of partnerships that can be set up, but general partners in the entity will still be personally liable for the debts and liabilities of the entity.
Resource for more information regarding a partnership entity. https://www.thebalancesmb.com/selecting-a-business-partnership-398880
Tax Considerations: The partnership is required to file a separate return but is not going to be responsible for paying any type of income tax, since all profits and losses will be passed on to the partners via the K-1. Partners cannot take a salary from the entity instead they can take guaranteed payments which will be subject to self-employment tax. Once profits are taxed on an individual’s return, any monies distributed from the entity are tax free if the partner has a basis greater than 0 in the entity.
Corporation – This is a legal entity created to conduct business and provides owners with the highest level of legal liability. Like a person, the corporation will pay taxes on it profits. The key benefit of a corporation is the avoidance of personal liability regarding the owners. Creating a corporation can sometimes be costly and require legal assistance. Double taxation is another term referred to when talking about a corporation, and what this means is the profits of the corporations is essentially taxed twice. Profits will be taxed at the corporate level and for a second time when an owner pays themself a distribution via a dividend.
Resource for more information regarding a corporation entity. https://corporatefinanceinstitute.com/resources/knowledge/finance/what-is-corporation-overview/
Tax Considerations: Corporations are required to file a separate tax return and pay taxes on their profits earned. Currently, corporations are all taxed at a flat rate of 21% but this will probably change with the New President.
Limited Liability Company – This is a quasi-entity type between a corporation and partnership. This entity type provides the most simple and flexible entity structure for an owner to set up and limit their personal liability. The owner’s liability is limited to the assets contributed to the LLC. This type of entity has become one of the more common entity selections of small businesses because of the ease of set up, liability protection provided to owners, and the flexibility of structure. For tax purposes an LLC can be treated as a sole prop, partnership, or S-Corp if owners file the proper paperwork to the IRS. LLC’s are considered pass through entities like partnerships and profits of the entity will be taxed at the individual level via a K-1.
Resource for more information regarding a S-Corp entity. https://corporatefinanceinstitute.com/resources/knowledge/finance/what-is-corporation-overview/
Tax Considerations: S-Corporations are required to file separate tax return but is not going to be responsible for paying any type of income tax, since all profits and losses will be passed on to the owners via the K-1. It is very important that S-Corp pay themselves W-2 wages, as this is a requirement by the IRS imposed on S-Corps.
It is always important to take some time and considerations when making your entity selection to ensure that the appropriate paperwork is filed and that the correct entity is selected for your new business. There are resources in the community such as the local SBA office, County Business Action Center, legal professional, or CPAs. It is important to mention that the business structure you start out with may not meet the needs in years to come as your business grows and evolves.
Taxes
So, you have chosen your business structure, have filed all the necessary paperwork with the State to get your business registered, and are now ready to open your doors and start business. As a business owner, you should be aware of the various taxes in the state that your business will be subject to in order to do business.
General excise tax (“GET”) – GET is a privilege tax imposed on business activity in the State of Hawaii. The tax is imposed on the gross income or cash receipts received by the person engaging in the business activity. Gross income is the total of your business income before business expenses are deducted. The State’s GET is very inclusive and for the most part covers majority of all income and cash collected by the business. GET is imposed at a 4% – 4.5% rate on businesses.
Resource for more information on GET: https://files.hawaii.gov/tax/legal/taxfacts/tf2015-37-1.pdf
Income Tax – Hawaii business income is subject to income tax via a business return or the business income that flows through the owner’s income tax return, via a K-1 or a Schedule C. Corporations in Hawaii are taxed at marginal rates between 4.4% to 6.4%. Individuals are taxed at marginal rates ranging from 1.4% to 11%. It is important to note, that income tax is based on your net business income which is equal to business income less any related business expenses, so business owners can reduce their income tax liability by reducing net income with higher business expenses, etc.
Payroll taxes – Once a business hires any kind of employee, they will then be responsible for filing and paying payroll taxes to the IRS and State of Hawaii. Payroll taxes can be complex, and it is something I recommend business owners to hire a third-party payroll provider to assist with. It is a bit pricier to hire a third-party provider, but with the additional expenses comes peace of mind that all your payroll taxes and filings are being accurately filed and completed.
There are many items one should consider when deciding to start a business in Hawaii and the two items listed above are two of the major tax considerations that will impact an owner’s business. Below is a page on the Hawaii government website that is a great resource to get you started when creating your business in the state.
https://portal.ehawaii.gov/business/starting-a-business/
If you have any additional questions, please feel free to email me at asitan@verity.cpa