There are many different types of business entities: sole proprietorship, general partnership, C Corporation, S Corporation and LLC (Limited Liability Companies).
A sole proprietor is an individual operating a small business as a self-employed person. The owner is liable for all business debts and actions and receives all the profits and losses from the business. If the proprietor’s net self-employment income is $400 or more, he or she also pays self-employment tax.
- It is easy to startup and keep records.
- There are few legal restrictions.
- The proprietor has total decision-making control.
- The owner can dissolve with minimal income tax consequences.
- The owner takes total risk for the business (financially and legally), this means the owners personal property can be confiscated.
- It is difficult to raise capital.
- Personal federal income tax cannot be deferred.
A partnership can be either general or limited, it is an association of two or more persons running a business. Each partner must contribute property or services and they share in the profits.Limited partnerships have only a limited amount of liability in the company. The liability is limited to the amount the partner invested.
- A partnership is easy to start-up. Many spouses use this to be equal owners in a business.
- Sometimes children can be partners and utilized to be taxed at lower rates.
- A partnership has legal status.
- Active partners can use losses to offset income.
- Partnership interests can be transferred to others.
- The partners take all the risks meaning general partners’ business and personal property are liable.
- Limited partners’ losses are calculated by the passive loss rules.
- General partners are subject to self-employment tax.
- Federal income tax cannot be deferred.
- There are state and federal reporting requirements.
- The business must terminate if more than 50% ownership changes.
A C corporation is a business entity that has its own legal identity, rights and liabilities. Corporations include the following characteristics: central management, limited liability of the owners, and the ability to transfer ownership. Typically, a corporation is formed by incorporating in the state in which it will conduct business. This is done by filing articles of incorporation and paying the state’s filing fees.
- A corporation exists until it is dissolved.
- A corporation can have multiple shareholders.
- Ownership can transfer through stock sales and have no tax effect on the company.
- Capital is easily attained through stock sales.
- A shareholder is only liable for the amount of investment in the corporation or for any debts guaranteed by him/her.
- Tax rates may be lower than individual rates.
- Children can be shareholders.
- Corporate income has double taxation, it is taxed at the corporate level and at the shareholder level as dividends.
- Personal service corporations are subject to a 35% tax rate.
- They are limited by their charters in regard to the type of business activities they can take part in.
- They are governed more closely by federal and state regulations.
- Corporations are not easily dissolved; they must be liquidated.
- The losses can only offset corporate income. There is no income pass through. Corporate losses are not passed through to shareholders but instead are carried to years when the corporation has profits.
An S corporation is formed the same way as a C Corporation and then Form 2553 is filed with the IRS to obtain the S status. Income from an S-corporation is taxed at the individual level. An S corporation can be own all or part of a C corporation or LLC. S corporations are subject to state requirements.
- S corporations protect from liability, an owner is only liable for his/her investment.
- Income is not taxed at a corporate level.
- Children can own shares of the S corporation.
- Ownership is completely transferrable.
- Income or losses from an S Corp can be used to offset other income.
- Though shareholders must have payroll they are allowed a reasonable profit not subject to self-employment tax.
- There is 100 shareholder limit and shareholders must be US citizens or residents (They cannot be corporations).
- Shareholders are taxed on the profits of the corporation even if there is no distribution.
- S corporations are required to file tax returns with the federal government.
A limited liability company (LLC) has the limited liability features of a corporation without many of the restrictions. LLCs have filing fees associated with the formation. LLCs are taxed as partnerships unless they elect corporate taxation. An LLC that has only one owner is taxed as a sole proprietorship unless it elects corporate taxation.
- An LLC is not limited to the number of owners or type of owners. (Non-US Citizens/Residents and corporations can be owners)
- LLCs do not have to file a separate form for status.
- Gains and losses are not subject to corporate tax they are passed on to the members.
- There is typically no gain recognized when property is transferred from the LLC to one of its members until the member releases it.
- A separate tax return is not filed.
- Ownership is transferrable.
- LLC members are subject to self-employment tax on the entire profit.
- Members must pay the income on the tax even if they have not received money from the organization.
- If ownership changes by 50% or more within the year, they must terminate the LLC.
- There may be special filing requirements based on the type of owners involved.