Trying to decide which form of entity structure is right for your business?
Choosing the right Business Structure
The most common forms of business are ...
sole proprietorship, partnership, corporation, and S corporation. A Limited Liability Company (LLC) is a relatively new business structure allowed by state statute. Legal and tax considerations enter into selecting a business structure. When beginning a business, you must decide what form of business entity to establish. Your form of business determines which income tax return form you have to file.
A sole proprietorship is an unincorporated business that is owned by one individual. It is the simplest form of business organization to start and maintain. The business has no existence apart from you, the owner. Its liabilities are your personal liabilities. You undertake the risks of the business for all assets owned, whether used in the business or personally owned. You include the income and expenses of the business on your own tax return.
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 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" any 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. 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.
A corporation is created under the laws of a state as a separate legal entity that has privileges and liabilities that are distinct from those of its members. A Regular "C" Corporation files it's own income tax return and pays it's own taxes on profits. This results in the old "double taxation" standard you may have heard about. After the corporation pays taxes on the profits, the shareholders may have to pay tax again when those profits are distributed to them (usually distributions occur in the form of dividends).
An eligible domestic corporation can avoid double taxation (once to the shareholders and again to the corporation) by electing to be treated as an S corporation. Generally, an S corporation is exempt from federal income tax other than tax on certain capital gains and passive income. On their tax returns, the S corporation's shareholders include their share of the corporation's separately stated items of income, deduction, loss, and credit, and their share of non-separately stated income or loss.
Limited Liability Company (LLC)
A Limited Liability Company (LLC) is a relatively new business structure allowed by state statute. LLCs are popular because, similar to a corporation, owners have limited personal liability for the debts and actions of the LLC. Other features of LLCs are more like a partnership, providing management flexibility and the benefit of pass-through taxation. Owners of an LLC are called members. Since most states do not restrict ownership, members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Most states also permit �single member� LLCs, those having only one owner. A few types of businesses generally cannot be LLCs, such as banks, insurance companies and nonprofit organizations. Check your state�s requirements and the federal tax regulations for further information. There are special rules for foreign LLCs.
This information is provided as a public service, and should not be construed as individual accounting or tax planning advice. For information on how these general principles apply to your situation, please consult your Cook & Co. Agent.
Depending on your needs, one type of organization will probably suit your business better than the others. If you outgrow one organization type, you can generally reorganize into a more suitable entity.
Greg Cook, EA, CPA
Accredited Tax Advisor
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Cook and Co., Enrolled Agents are licensed by the U.S. Treasury Department to represent taxpayers before the Internal Revenue Service (IRS). Greg Cook is a Certified Public Accountant (CPA) licensed by the states of Alabama and Tennessee.