Basic Overview of Business Structures
When starting a business, one must decide what form they want their business entity to establish. This form determines which income tax forms that need to be filed. The most common forms of business entities are sole proprietorship, partnership, corporation, and S corporation. A Limited Liability Company (LLC) is a business structure that is authorized by state statute. Selecting what form you want your business entity to establish is arguably the most important aspect of starting a business as there are numerous legal and tax considerations to consider.
A sole proprietorship is someone who owns an unincorporated business by himself or herself. However, if you are the sole member of an LLC, you are not a sole proprietor if you elect to treat the LLC as a corporation.
Some advantages of a Sole Proprietorship include: Easy and inexpensive to form, complete control, and easy tax preparation.
Some disadvantages of a Sole Proprietorship include Unlimited personal liability, harder raising money, and the heavy burden involved in the success or failure of the business.
A partnership is a relationship between two or more people to do trade or business. Each person contributes money, property, labor, or skill, and shares in the profits and losses of the business.
There are two common kinds of partnership: limited partnership (LP) and limited liability partnerships (LLP). LPs have only one general partner with unlimited liability, and all other partners have limited liability. Partnerships are generally a good choice when multiple owners want to test their business ideas before forming a more formal business.
This is where things start to get a little tricky as there are a few different forms your business can take. In informing a corporation, prospective shareholders exchange money, property, or both, for the corporation’s capital stock. Generally, a corporation takes the same deductions as a sole proprietorship to figure its taxable income. Profits of a corporation are taxed when earned, and then taxed when to the shareholders when it is distributed as dividends.
S Corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual tax rates. Doing so allows S corporations to avoid that double taxation on their corporate income. S Corporations are still responsible for tax on built-in gains and passive income at the entity level.
Limited Liability Company (LLC)
An LLC is a business structure that is allowed under state statute. Each state will likely have different rules and regulations controlling LLCs so it is imperative to check with the state that you are interested in forming your LLC. LLCs are good choices for medium or higher-risk businesses, for owners with significant personal assets they want to be protected, and for owners who want to pay a lower tax rate than they would with a corporation.
For more information about Business Structures and assistance with forming a business, please reach out to the professionals at the Center for Financial, Legal, and Tax Planning, Inc., at (618) 997-3436.