When starting a new business, you must decide what form of business entity to establish. The form of business structure chosen determines which income tax return form you have to file. The most common forms of businesses are the sole proprietorship, partnership, corporation, and S corporation. A Limited Liability Company (LLC) is a business structure allowed by state statute. You may not be held personally liable for debt and obligations that you incur on behalf of your business if you form an LLC.  Check with legal counsel in your state as to your LLC legal protection. A one-member LLC can be treated as a sole proprietorship or a corporation. A two or more member LLC can be treated as a partnership or as a C or S corporation. Legal and tax considerations as well as personal goals should be evaluated when selecting the correct business structure. 

Business Structure #1: Sole Proprietorship

A sole proprietor is someone who owns an unincorporated business by himself or herself. In a sole proprietorship, you report your revenues and expenses on your individual income tax return. Net income is subject to self-employment taxes and the owner is not allowed to take a W-2 wage. 

Business Structure #2: Partnership

A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expenses to share in the profits or losses of the business. The partnership files a separate return but does not pay income tax. The net income (loss) flows through to the partners and each partner reports their share of income or loss on their personal returns. The net income may be subject to self-employment taxes. Partners do not receive wages but can receive guaranteed payments which are a deduction of the partnership and are reported on the partner’s personal return as income. There are three relatively common partnership types; general partnerships, limited partnerships and limited liability partnerships. Partnerships are easy to create and minimal state filing may be required. The type of partnership that is chosen will determine your legal liability. Please contact your legal advisor regarding the partnership’s legal liabilities in your state.  

Business Structure #3: C Corporation 

In forming a corporation, prospective shareholders exchange money, property or both for the corporation’s capital stock. For income tax purposes, a C Corporation pays taxes and distributes profits to an owner. The profit of a corporation is taxed when earned and then is taxed to the shareholder when distributed as dividends. This is referred to as double taxation. A C Corporation could possibly afford the owners greater legal protection. Please contact your legal advisor for any legal liability questions. 

Business Structure #4: S Corporation

S Corporations are corporations that elect to pass corporate income, losses, deductions and credits through to the shareholders for tax purposes. To qualify for S Corporation status, the corporation must meet the following requirements: the S Corporation must be a domestic corporation; the number of shareholders is limited to 100; and shareholders are not allowed to be partnerships, corporations or non-resident alien shareholders. 

Federal and state tax laws are constantly changing, therefore it is in your best interest to hire a CPA to consult on the best business tax structure. Everfore CPAs & Advisors can help you to navigate the complexity of these tax laws.