A sole proprietorship is one individual that is conducting business. This business entity structure is very easy to form since nothing is required to be a sole proprietor. There is no state filing requirement however, if the owner wants to use a business name different from their legal name, a DBA needs to be filed. The business owner reports the profits or losses of the business on the personal tax return. The downfall of this simple structure, is the owner’s personal liability for the business. The owner is personally liable for business debt which could cost them their savings, investments or potentially their personal property. Owners are also responsible for self-employment taxes at the current rate of 15.3% on all profits.
When two or more people are working together by default they are considered a General Partnership. Like a sole proprietor, the partners in a general partnership are held liable for business debts and liabilities. To reduce the risk of liability, a limited partnership can be created. In a limited partnership there are general partners and limited partners. The general partner manages the day to day activities of the business and has unlimited liability for the debts of the partnership. The limited partner has limited liability, but is not allowed to participate in the management of the partnership.
A corporation is a very common entity structure because it provides a layer of protection between the business and the owners. Since a corporation is a separate legal entity from the owners, the paperwork required and tax preparation become a bit more cumbersome. Unlike a sole proprietor or partnership, in order to form a corporation, the required state documents must be filed and approved. Corporations are also required to file a corporate tax return separate from the owner’s individual tax return. This is double taxation, the corporation is taxed on income and then the shareholders are taxed on the profits after taxes. In order to avoid double taxation the corporation can elect S-Corp status. With this election, profits and losses of the corporation will pass through the company to the shareholders (owners) to report on their individual tax return.
Limited Liability Company (LLC)
Although the LLC structure has only be around since the 1970s, they have become a very popular business structure for entrepreneurs. LLCs offer the same level of asset protection as corporations without all the formalities and internal paperwork requirements. An LLC also has many tax options, the LLC can choose to file taxes like a corporation, where the corporate income is taxed or they can opt for a pass through tax option where the profits pass through to the business owners to report in the personal tax returns. It is important to check that the state the LLC is formed in has updated their tax laws to reflect the IRS federal tax regulations.
A nonprofit corporation is formed to benefit: the public, a specific group of individuals or the member of the nonprofit organization. Some examples of nonprofit corporations are charitable organizations, homeowner associations, political organizations and religious organizations. Unlike a corporations, non-profits do not have shareholders (owners). The nonprofit is managed by the board of directors and officers. Nonprofits also qualify for state and federal tax benefits. Just like a corporation, directors, members, and employees are not responsible for corporate debts and liabilities.
Choosing a business entity structure is not something to do lightly. It is important to research the pros and cons in order to make an informed decision. Make sure to weigh all the options and think about what will benefit the business now and in the future. If you cannot determine what is best for your business, speak with an accountant or lawyer to get more insight.
Business Filing Section