BUSINESS ENTITIES AND STRUCTURES
An important issue facing all new businesses is choosing the proper business entity type or structure, a decision that impacts tax reporting requirements and liabilities. In learning about and choosing the proper business entity, you will also learn how to best view your business endeavor, simplify and understand its business aspects, and minimize your tax liabilities. This is a short overview of the most common entity forms.
A Sole Proprietorship is an unincorporated single owner business (most of us). It is not separate from the individual. If you have not set up another business type, your business venture is a sole proprietorship. This is the simplest form of business to run. Your income and expenses are filed as part of your personal tax return on a Schedule C.
One disadvantage to a sole proprietorship is in regards to liability. Your personal assets are at risk for your business liabilities. If this is an issue for you (living in the land of lawsuits as we do), you may want to consider a business entity that affords you certain liability protection. You also may be losing strategic tax savings that you could potentially have with other business structures.
A partnership is similar to a sole proprietorship, but contains multiple owners. It is possible for several sole proprietors to share certain expenses, e.g., co-leasing an office, without establishing a partnership; however, when income and expenses are shared, a partnership exists and should be reported as such.
A partnership files a separate Form 1065 Partnership tax return, and the profit or loss then flows through to each partner’s personal return, based on percentage of ownership. It is advisable to have a written partnership agreement that determines the percentage of ownership and profit/loss sharing.
A partnership also faces the same dangers of personal liability as a sole proprietor. Recently, many people prefer to form an LLC instead. (This is done within your local State. We currently offer this service to Alaskans! Click here if you’d like more information!)
LIMITED LIABILITY COMPANY (LLC)
An LLC is a newer type of business entity, allowed by state statute. LLCs are popular because they combine the benefits of the simpler reporting requirements and the flow-through characteristics of sole proprietorships and partnerships with the limited personal liability for the debts and actions of the business (like a corporation).
A single-owner LLC reports income and expenses on a schedule C, like a sole proprietorship. Multiple member LLCs report on the Form 1065 Partnership Tax Return (unless an election for treatment as a corporation is made. That’s a whole other can of worms).
The traditional corporation is a “C” Corporation. It is a completely separate entity from its owners. It files AND pays its own tax. You would become an employee of your corporation, and receive a W-2 for work done. Any profits taken from the corporation would first be taxed to the corporation and then again to you personally as dividends. Reporting and record-keeping requirements are stricter than for other entity types. This type of entity is advisable for very large, highly profitable ventures, especially when start-up capital is required and you need to bring on investors.
An S Corporation avoids the double taxation of the C Corporation. It reports income and expenses similar to a C Corp, but does not pay its own tax. Instead the profit or loss flows through to the owners’ personal returns, more like a partnership. There are requirements to pay wages to the owners (if work is being done and company is profitable), making the reporting requirements more difficult than that of a partnership or LLC; however, there are certain tax advantages to an S corporation, especially one that is profitable.
This is a very limited overview of business entity types. We suggest you do further research or talk with a tax and/or legal professional prior to forming a corporation or partnership. Each situation is different, and each business entity has its advantages and disadvantages.