What Business Structure Should I Choose?

One of the first hurdle most potential business owners face is making a decision on the type of business structure that is best for their business.  The most frequently asked question is “should I incorporate or form an LLC, which one is better”?  In our previous blog, “So You Want to Start a Business”, we discussed the general steps to take in forming a business and getting registered.  This blog provides insight on the different structures of business and some of the pros and cons associated with them. 

Below are the main business structures, keeping in mind that Corporations and Partnerships has several types within the structure, such as professional corporations, non-profit organizations, general partnership, limited partnerships (LP), and limited liability partnership (LLP).

 The Main Business Structures are:

  • Sole Proprietorship – This is the most common structure because of the ease of set-up and the low cost associated with it and less formalities.  A sole proprietor is someone who owns an unincorporated business.  Some sole proprietors will register a ‘doing business as’ DBA with the state of residency and also obtain an EIN number.  For tax purposes, the sole proprietor would report the activities of the business on his or her individual income tax return (Form 1040) on Schedule C.

          Pros

         – Easy to Form

         – Tax paid on income of the business on personal tax return

          – No double taxation

         Cons

         – No personal liability protection

         – Self-employment taxes

  •  Partnerships – This is structure is usually formed based on an existing relationship between two or more persons who wish to do business together.  Each person contributes to the partnership and shares in the profits and losses of the business.  For tax purposes, the partnership would file a return partnership income (Form 1065) which is a pass through return, and provide each partner with a K-1, to report the income or loss in the partnership on their individual income tax return (Form 1040) on Schedule E.

           Pros

           – Income taxed proportionately to partners

           – No double taxation

           Cons

          – No personal liability protection (Unless LP, LLP)

  •  Corporations – This structure has more filing requirements and is formed when shareholders exchange money, property, or both, for the corporation’s capital stock.  For tax purposes, the corporation is a separate tax paying entity from its shareholders.  The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends.  This is known as a ‘double taxation’.  The corporation would file a C Corporation return (Form 1120).

          Pros

          – Personal liability protection

          – Perpetual existence

          – Board governance

          – Corporate tax rate does not go as high as sole proprietors

         Cons

         – Double taxation

         – More expense to establish

         – Regulatory requirements

         – Cannot deduct losses

  • S Corporations – This structure is corporation that has elected to pass income, loss, deductions, and credits to their shareholders for federal tax purposes.  In order to become an S corporation, the corporation must submit Form 2253, signed by all shareholders and to qualify, must meet certain requirements, such as being a domestic corporation, having only one class of stock and no more than 100 stockholders.  For tax purposes, the S Corporation would file an S Corporation return (Form 1120S) which is a pass through return, and provide each partner with a K-1, to report the income or loss in the partnership on their individual income tax return (Form 1040) on Schedule E.

          Pros

           – Personal limited liability for shareholders

           – No double taxation

          Cons

         – Limited number of shareholders

         – More expensive to establish

  • Limited Liability Company (LLC) – This business structure is allowed by state statue and each state may use different regulations.  It is advisable that you check with your state if you are going to form an LLC.  Owners of an LLC are called members and most states allow a “single-member” LLC; those having only one owner.  For tax purposes, the IRS treat an LLC as either a corporation, partnership, or as part of the LLC’s owner’s tax return (a “disregarded entity”). An LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 elects to be treated as a corporation. And an LLC with only one member is treated as an entity disregarded as separate from its owner for income tax purposes, unless it files Form 8832 and affirmatively elects to be treated as a corporation.

          Pros

          – Personal limited liability for members

          – No double taxation

          – More flexible and ease of management

          – No limits on number of members

          Cons

         – Members subject to self-employment taxes

Hopefully this blog provided valuable insight on what to expect if you plan to start your own business. For more information and insight contact us at (301) 797-8259

 

 

 

 

 

 

 

 

 

 

 

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