| Selecting Your Business Form
One of the most important decisions that you will have to make in connection with starting a business is the legal form in which to operate your business.
There is tax consequences for each business form. Comparing the tax and non-tax issues for each business form will help you operate and grown your business.
A sole proprietorship can be defined as any unincorporated business with a single owner. It's the most commonly used form for new small businesses. From the IRS's perspective, the business is not a taxable entity. All of the businesses assets and liabilities are treated as belonging directly to the business owner. For tax purposes all income and expenses generated by the business are reflected on either Schedule C, included as part of your annual individual tax return.
A partnership is an unincorporated business with two or more owners. A partnership is not a taxable entity under federal law — there is no separate partnership income tax, as there is a corporate income tax. Instead, income from the partnership is taxed to the individual partners, at their own individual tax rates. The partnership is required to file a tax return (Form 1065) that reports its income and loss to the IRS, and also reports each partner's share of income and loss on Schedule K-1 of the 1065.
The limited liability company (LLC) is a hybrid of a corporation and a limited partnership that is created under state law. For federal tax purposes, an LLC is treated identically to a partnership and it must file a Form 1065, U.S. Partnership Return of Income. Under state laws, LLC owners are given the protection from liability that was previously afforded only to corporate stockholders. Although the LLC is a relatively new business form, all of the states have now enacted legislation providing for limited liability companies.
From a tax perspective, there are two options for corporations under federal income tax law:
- C corporations are what we normally consider "regular" corporations and are subject to the corporate income tax.
- S corporations are corporations that have filed a special election with the IRS. They are not subject to corporate income tax but are treated as similar (but not identical) to partnerships for tax purposes.
There are a number of nontax factors that may influence your decision as to whether a corporation is the right form of business for you, and we recommend that you seek expert legal advice in setting up a corporation and writing up the articles of incorporation. |
