When starting a business, one of the first things to decide is which business structure to choose for your enterprise. The form of business you choose will impact your legal and tax obligations, including which income tax return you file. Some of the most common types of business structures most commonly used by businesses are discussed below.
In a sole proprietorship, you are the only owner of the unincorporated business. There is no legal distinction between the owner and the business. The owner is the only person responsible for the payment of taxes, profits and losses. It is a common type of business structure for small businesses and startups.
If you are the sole member of a domestic Limited Liability Corporation (LLC) and you treat it as a corporation, then you are not considered a sole proprietor.
As a sole proprietor, you may be required to file the following tax forms:
- Income tax
- Self-employment tax
- Estimated tax
- Federal unemployment tax (FUTA)
- Information returns
- Excise taxes
In a partnership, there are two or more joint owners of the business. Each partner contributes funds, effort and resources, and shares the profits and losses of the business.
Business owners in a partnership are required to file an annual information return to report the business’ income, gains and losses. A partnership does not pay income taxes. It passes over the profits and losses to the owners, and they pay their share of taxes depending upon their income from the business.
The partnership issues copies of Form 1065 (Schedule K-1) to the partners, which they are required to file. Partners do not use a W-2, as they are not employees.
In a corporation, prospective shareholders exchange funds, and/or property to create the corporation’s capital stock. A corporation calculates the net income or losses, pays taxes on income, and distributes the profit to its shareholders. The shareholders pay taxes on the dividends they receive. That causes double taxation.
To avoid double taxation, corporations elect to be S corporations. In an S corporation, shareholders report and pay taxes on their personal tax returns at their individual tax rates, and avoid double taxation.
Limited Liability Company (LLC)
LLCs are business structures allowed by state statute and, therefore, have different regulations depending upon the state in which they operate. Owners of a Limited Liability Company are called members. An LLC with one member is known as a single-member LLC. Check your state’s regulations to see if they permit a single-member LLC.
Members of an LLC can be individuals, corporations, other LLCs, and foreign entities. There are no restrictions on the maximum number of members in one LLC. Banks and insurance companies cannot be LLCs. Check your state regulations regarding LLCs to make an informed decision.