Do you know which Business Structure to choose when starting a New Business? JD Supra.
When opening a new business, electing a business structure is an important decision. The business structure elected can affect how much will be paid in entity income taxes, record-keeping requirements, how much personal tax liability might be incurred, if any, and which Tax Forms are due. The most common types of business structures are:
- Sole Proprietorship: A sole proprietor (SP) is someone who owns an “unincorporated” business by himself or herself. This is the simplest way to open a new business as it does NOT require the owner to create a separate legal entity. The owner’s business assets and liabilities are NOT separated from his or hers personal assets and liabilities. For tax reporting, some of the Forms are: 1040 (US Individual Income Tax Return) and Schedule C (Form 1040), Profit or Loss from Business. There is also Self-employment tax (Schedule SE on Form 1040), Social security and Medicare taxes and income tax withholding (Forms 941, 943 and 944). Providing information on social security and Medicare taxes and income tax withholding for employees is via Forms W-2 and W-3. There could be Federal unemployment (FUTA) tax, filing information returns for payments to nonemployees and transactions with other persons and Excise Taxes.
- Partnership: In a partnership, there is a relationship between two or more persons who jointly carry on a business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business. A partnership must file an annual information return to report the income, deductions, gains, losses, etc., from its operations, but it does not pay income tax. Instead, it “passes through” its profits or losses to its partners. Each partner includes his or her share of the partnership’s income or loss on his or her tax return where appropriate. Partners are not employees and should not be issued a Form W-2. The partnership must furnish copies of Schedule K-1 (Form 1065) to the partners by the date Form 1065 is required to be filed, including extensions.
There are two types of partnerships: limited partnerships (LP) and limited liability partnerships (LLP). In a LP, there is one general partner with unlimited liability, and all other partners have limited liability. The partners with the limited liability will have limited control over the company. The profits are passed through to personal tax returns, and the partners must also pay self-employment taxes when appropriate. There needs to be a Partnership Agreement to outline the control and responsibilities of the Partners.
The LLP work similarly to the LP, but gives limited legal liability to every owner. In an LLP, each partner is protected from debts against the partnership and won’t be responsible for the actions of other partners. The LLP is a common business structure for attorneys and CPAs.
- Corporation: A corporation is a separate taxpaying legal entity that conducts business realizing net income or losses and paying taxes and distributes profits to its owners – known as shareholders. A corporation (also known as a C-corp) provides personal liability protection to its shareholders. Corporations can raise capital through the sale of stock. They can also go public or be sold. C-corps are “on-going” concerns and operate independently from their shareholders. Corporations have to file Form 1120 (US Corporation Income Tax Return), Form 941 (Employer’s Quarterly Federal Tax Return) and Form 940 (Employer’s Annual Federal Unemployment (FUTA) Tax return) and excise taxes. The corporation carries the concept of “double taxation” as the profit of a corporation is taxed to the corporation when it is earned, and then is taxed to the shareholders when it is distributed to them in the form of dividends.s
- S Corporations: They are also known as S Corps. They are legal entities that are designed to avoid the double taxation of a C corp. The S corps allows profits, and some losses, to be passed through directly to owners’ personal income without being subject to corporate tax rates. The IRS must grant an S Corp its status via Form 2553. It can’t have more than 100 shareholders and all shareholders must be US persons. It has to be a domestic corporation and have only one class of stock. This type of structure is NOT available to financial institutions, insurance companies, and domestic international sales corporations. S Corps must file Forms 1120S and 1120S Sch. K-1, Forms 940, 941 and 943, 8109 (FUTA) and excise taxes among others. The shareholders of an S-Corp must file Form 1040 and Schedule E and other forms referenced on the shareholder’s Schedule K-1.
- Limited Liability Company: This legal entity (LLC) combines the benefits of a corporation and a partnership business structure. The LLC is a business structure created by state statute. The owners of an LLC are called members. The members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members and many states permit a “single-member” LLC (having only one owner). The IRS will treat an LLC as either a corporation, S-Corporation, partnership, or as part of the LLC’s owner’s tax return (also known as a “disregarded entity”). An LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and affirmatively elects to be treated as a corporate entity. An LLC with only one member (disregarded entity) is not treated as separate from its owner for income tax purposes (but as a separate entity for purposes of employment tax and certain excise taxes), unless it files Form 8832 and affirmatively elects to be treated as a corporation.
The Single Member LLC activities should be reflected on its owner’s federal tax return. If the owner is an individual, the activities of the LLC will generally be reflected on:
- Form 1040 Schedule C, Profit or Loss from Business (Sole Proprietorship)
- Form 1040 Schedule E, (Supplemental Income or Loss)
- Form 1040 Schedule F, ( Profit or Loss from Farming)
A disregarded entity generally must use the owner’s social security number (SSN) or Employer Identification Number (EIN) for all information returns and reporting related to income tax. Most new single-member LLCs classified as disregarded entities will need to obtain an EIN and will need an EIN to open a bank account.
Business owners ought to choose a structure that is viable, provides protection from their personal assets and can promote the fundamental for success and growth. Consulting with your tax specialist is important in determining which structure is the right one.