The most common forms of business are sole proprietorship, partnership, corporation, and S corporation.
You might also see the term “Limited Liability Company” or LLC.
With an LLC, members may include individuals, corporations, other LLCs and foreign entities. Since there is no maximum number of members, most states also permit what is called a “single-member” LLCs. As that name suggests, there is one owner.
While I am not an accountant nor lawyer and do not play one on TV, you should know the very basics of each type of entity before you talk with your accountant or lawyer about what is best for you.
Sole Proprietorship
A sole proprietor is someone who owns an unincorporated business by themself.
Like most of the tax law, there are exceptions to the rule. One such exception is if you are the sole member of a domestic limited liability company (LLC). You are technically NOT a sole proprietor if you elect to treat the LLC as a corporation.
A sole proprietor’s trade or business income is reported on Schedule C of Form 1040.
For more information about how a sole proprietorship is taxed, check out the IRS Sole Proprietorships web page.
Partnership
A partnership exists when between two or more persons legally join to conduct trade or business. Each partner 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 at the partnership level.
While the partnership does not pay income, income tax will be paid, at the partner level.
The partnership “passes through” any profits or losses to the partners. Then each partner is required to pay income tax based on their share of the partnership’s income or loss on their tax return.
If you are interested in more information about partnerships tax situation, check out IRS Publication 541: Partnerships
Corporation
Apple Inc., Walmart Inc., and Microsoft are examples of C-Corporations, or more commonly referred to as corporations.
In the process of forming a corporation, prospective shareholders exchange money, property, or both, for the corporation’s capital stock.
For federal income tax purposes, a C corporation is recognized as a separate taxpaying entity. A corporation conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders.
S Corporation
The IRS web defines an S-Corporation as “corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income at the entity level.”
If you are interested in setting up this type of corporation, you need to meet a number of IRS requirements found here.
Next Steps
Now that you have a general idea of the types of business structures there are, it’s time to sit down with your accountant and/or lawyer and go through your specific situation and legal needs.
Taxes are but one area for consideration.
Liability is another.
America is a litigious society. People can, and will, sue you for just about any reason. Having the correct form of business structure can help you deal with liability issues.
As the old adage goes, “An ounce of prevention is worth a pound of cure.”
