Thinking of taking your idea from a pet project to a fleshed-out business? As you begin to start your business one factor to decide on is what type of business entity you will have. A business entity is an organizational structure created by an individual or individuals to conduct business or engage in a trade. There are several different forms of business entities – and the right one for you may take time to settle on. It’s important to talk to tax and legal counsel before deciding as they can help give you a clearer picture of the best decision.
There are five entities that are the most common: Sole Proprietorships, Partnerships, C Corporations, S Corporations, and Limited Liability Company (LLC). Depending on which entity you decide is the best fit for your business determines which income tax return you will need to file. This blog is a quick glance at what each of these entities means. And stay tuned to our website to see more blogs covering the different types of entities over the coming months in more detail!
Sole Proprietors
A sole proprietor is the only owner of an unincorporated business. No one else holds a stake in the company, nor is the ownership shared with a friend or partner. Taxes are reported on Schedule C as part of your 1040 return. You pay the taxes personally along with the self-employment tax.
Partnerships
Running a business with friends or partners is an often-taken route by new businesses. A partnership is an existing relationship between two or more individuals who partner in carrying a business. Everyone involved contributes money, property, labor, and/or skill to the project and shares in the profits and losses of the business. Any income or loss from the partnership would be reflected by the annual return based on the operations; however, it does not pay income tax. Rather it passes through any profits or losses to the partners. Partners would report their share of the profits or losses on their own tax returns.
C and S Corporations
A corporation is formed by prospective shareholders exchanging money, property, or have stake in the capital stock for the corporation. The exchange then grants them stock in the company and allows them to have a say in the direction of the company. The profits of a corporation are taxed doubly whenever dividends are declared, once when the profits are earned by the corporation and again when a dividend is paid to the shareholders.
Similar to a traditional corporation (or C Corporations), are S Corporations. These corporations chose to pass on the income, losses, deductions, and credits to their shareholders for federal tax reasons. S corporation shareholders report the income and losses on their personal returns, allowing them to avoid the double tax that occurs with C corporations. There are a few specific requirements laid out by the IRS to meet S corporation status: be a domestic corporation, have allowable shareholders, no more than 100 shareholders, only one class of stock, and be an eligible corporation.
Limited Liability Company-LLCs
Each state has different statutes regulating the business structure of a Limited Liability Company (LLC). Owners of an LLC are considered members of the business. Members can take many forms ranging from individuals, financial institutions, foreign companies, and even other LLCs. There are cases of LLCs being made up of a single member. Banks and insurance companies cannot be formed as an LLC; check your state’s regulations to see other business that may be ineligible to be an LLC. If you’re in Virginia, you can check their regulations here. For Maryland, their regulations are located here, starting on page 9. For other states, a simple Google search can turn up results on specific guidelines for your area. And of course, check in with your CPA or business advisor for personalized and knowledgeable help. Single member LLCs are taxed as a sole proprietor; multimember LLCs are taxed as a partnership unless they make the election to be taxed as a C or S corporation.
Want to Learn More?
Finding the right business entity for you may be a daunting task at first. Talk with your CPA, legal consultant, and business professionals to make the wisest choice for you. More information is available on the IRS website as well as with local government websites. Over the next few months, we’ll be posting more detailed blogs on the different business entities. Want to chat with us? Set up a meeting with one of our staff on our website. You can also give us a call at (703) 912-7862 or email us.
