1. Forms, Forms and More Forms

Regardless of what entity type you own, each entity has a long list of business tax forms that must be filed. Even the simple one-person sole proprietorship has a much more complicated tax return than the W-2 employee. And if you decide to incorporate your business or form a partnership or LLC, things get even more complicated. Each entity type requires special tax forms.

Perhaps you've been comfortable preparing your own tax returns when you were an employee. Now that you own a business (even a simple sole proprietorship), the consensus among experienced business advisors is simply this -- when it comes to preparing your business tax returns, don't try this at home. Swallow any "I-can-do-it-myself" pride and get some help.

2. Strive to Understand the Basics

If you're a sole proprietor (or LLC being taxed like a sole proprietor), all the required business tax forms are filed as part of your personal income tax return. The two most commonly required forms are Schedule C and Schedule SE.

If you're an S corporation or a partnership, or an LLC that is being taxed like a S corporation or partnership, you must file a separate business tax return, but technically the business doesn't pay any income tax. The S corporation files Form 1120S; the partnership files Form 1065. If you look on these forms, the heading says "income tax return." But the S corporation or partnership (or LLC being taxed like a S corp or partnership) does not actually pay any income tax. In effect, this so-called "income tax return" (Form 1120S or Form 1065) is an information return, giving the IRS a summary of the business' income and expenses.

The S corp and partnership then give the business owners a Schedule K-1, which reports each owners' share of the business' profit or loss. The owner then reports this K-1 information on his/her personal income tax return (Form 1040), where the income is taxed or the loss is deducted.

The C corporation files Form 1120, as does the LLC being taxed like a C corporation. The C corporation is the only business entity that pays its own income tax.

The LLC doesn't have a LLC-only tax return form. For tax purposes, the LLC is like a chameleon and can be taxed like a sole proprietorship, partnership, S corporation or C corporation. So it will file whatever tax form is required for the type of entity it has chosen to be treated like for tax purposes.

3. Beware the Dreaded Double Taxation of Corporate Profits

If you are thinking about forming a C corporation, remember that it pays income tax on its profit not once, but twice. Do you understand what that means? If you want to enjoy the legal benefits of incorporation (and there are many), then you must come to grips with this issue -- how are you going to legally avoid the possibility of paying both corporate and personal income tax on your business profit?

There are legal strategies available to the small business owner to avoid the dreaded double taxation of corporate profits. For many, forming an S corporation is a good option. If you are giving thought to incorporating, you should also give serious consideration to applying for S corporation status with the IRS. Be sure to consult with a competent tax professional on this issue.