Role of IRS the Role

Role of IRS

The Role of the IRS in for-Profit and Non-Profit Businesses

A famous quote from Benjamin Franklin states that "nothing is certain in this world but death and taxes." The fact that, at least in the United States, the certainty of taxes is as great as the certainty of death can be attributed to the enormous and powerful agency known as the Internal Revenue Service (IRS). According to its website, the stated mission of the IRS is to "provide America's taxpayers top quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all." While Congress is the body responsible for creating tax laws and policies, the IRS bears the brunt of educating the public about these laws, collecting the appropriate taxes, and levying punishments against those who do not comply. It is a complex job; in 2010, the IRS processed over 230 million tax returns, and collected tax revenue of over $2.3 trillion (www.irs.gov).

While many Americans are familiar with the IRS through the yearly ritual of filing their personal income taxes, the IRS is also tasked with overseeing the tax liabilities of for-profit and non-profit businesses. The tax code for these entities can be complicated, and an understanding of the IRS's role in controlling and collecting these taxes is crucial for any business owner or non-profit director. One important consideration that guides how the IRS interacts with a business is how the entity in question is structured. For small businesses and corporations there are several types of incorporation, each of which impacts tax liability.

The main types of for-profit business structures for IRS purposes are sole proprietorships, general partnerships, LLCs, S corporations, and C corporations.

The simplest type of business for tax purposes is the sole proprietorship. This is the structure is generally chosen by people who are in business for themselves with no other employees. Income generated by the business is considered personal income, and is taxed at personal income rates. The IRS monitors the taxation of sole proprietorships by having business owners file Schedule C, Profit or Loss for Business (Sole Proprietorship) along with their 1040 personal income forms (Mancuso, 2010). In addition, the sole proprietor must pay self-employment taxes (Medicare and Social Security).

General partnerships are similar to sole proprietorships, but have more than one owner. To stay compliant with the IRS, general partnership companies must file the IRS Form 1065, and each partner must file the Schedule K-1 in addition to their 1040s. Like the sole proprietorship, partners in a general partnership are also responsible to the IRS for their self-employment taxes (Ibid).

LLCs, or limited liability corporations, are an appealing option for many business owners because they offer some of the benefits of sole proprietorship while mitigating some of the risk. While LLCs are "pass-through entities" in terms of their tax liability, meaning the income of the business is considered personal income of the owner or owners, LLCs protect the owner(s) from personal responsibility for debts and liabilities incurred by the business (Daily, 2010). In terms of reporting to the IRS, LLCs use the same schedules and forms depending on how many members are in the company.

Corporations are another option for businesses. Corporations are both legal and tax entities. Legally, they are considered a separate "person" responsible for all actions, debts and liabilities of the company. For purposes of the IRS, corporations are divided into two different types: C corporations and S corporations. C corporations are named for Subchapter C, the section of the IRS that governs this sort of corporations (Mancuso, 2010). C corporations file taxes as separate entities, with the owners or partners taking salaries as personal income. Corporate taxes are filed through Form 1120, U.S Corporation Income Tax Return. This is an advantageous system from some businesses because corporate income is taxed at a lower rate than personal income under a certain level.

S corporations are legally incorporated entities whose tax status is treated the same as an LLC, with business income "passing through" to the owners' and partners' personal income and being taxed at personal income levels. It is increasingly less popular as an option because LLCs offer the same tax structure without the hassle of legal incorporation.

As important as choosing the right legal and tax entity is for a for-profit business, it is even more important for a nonprofit organization. Many nonprofits qualify for tax-exemption, but registering as a nonprofit with the state does not automatically make the organization a tax-exempt entity. In order to be considered a tax-exempt organization, a nonprofit must qualify as a 501(c)3 organization with the IRS. The IRS has strict regulations governing what sort of entities qualify as 501(c)3 organizations.

According to IRS's Exemption Requirements for charitable organization, in order to qualify as a 501(c)3 organization, a nonprofit must meet three important criteria. First, it must be "organized and operated exclusively for exempt purposes;" these purposes are limited to "charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals" (www.irs.gov).

Second, none of its earnings may benefit any private interests or persons. The IRS has careful controls in place to ensure that no net income from 501(c)3 organizations inure to any private shareholders, their families, friends, or anyone else with a personal stake in the charitable organization (Ibid).

Finally, a 501(c) 3 organization cannot organize a substantial amount of its activities towards political lobbying or in support of or against any particular political candidate. While lobbying is not altogether forbidden for charitable organizations -- indeed, it is an important aspect of many nonprofit agendas -- there are many restrictions that the IRS imposes in order to ensure that exercising political influence is not the primary activity of the tax-exempt nonprofit.