So you have a bang-up idea for a business, and you're willing to commit your heart and soul to getting it up and running. How will you structure it? Though you may have a personal preference, you should understand the views of the IRS. You'll be filing tax returns, and different types of businesses have different filing requirements. The IRS recognizes five types of businesses: sole proprietorship, partnership, corporation, S corporation and limited liability company or LLC.
Many small businesses go the sole proprietorship route. Its name says it all: One person is in charge and accepts all responsibilities, debts, losses and obligations. On the plus side, the owner also receives 100 percent of the profits. Another bonus: The owner simply has to file the standard 1040 tax form along with Schedule C, which identifies profits, losses and expenses. Sole proprietorship businesses are great because they cost nothing to set up. Still, you're legally responsible for business debts, and obtaining funding can be difficult. You can't sell stock, and banks are often leery of burdening just one person with a hefty loan.
When at least two people own a business, it's a partnership. Each supplies assets and splits profits and losses. In general partnerships, responsibilities and finances are evenly divided. Within limited partnerships, the liabilities and executive duties are based on the percentage of each person's financial contribution. Joint ventures are like general partnerships but have a designated end point. All partnerships must register with local, state and federal tax agencies and file annual reports. However, these businesses are not responsible for taxes. Partners report business income or losses on their personal tax returns.
Shareholders own a corporation, or C corporation, but only the business is responsible for its actions and liabilities. Corporations are typically big companies established through legal agreements. Each state has specific requirements for corporations launched within its boundaries. Businesses are responsible for local, state and federal taxes on profits. In addition, shareholders must often pay personal taxes on their earnings.
To avoid this double payment of taxes, some C corporations become S corporations, or S corps. A corporation must apply to the IRS for the S corp. designation and fulfill certain requirements, including having 100 or fewer shareholders and being established in the U.S. or under its laws. An S corp. doesn't pay federal taxes; all profits and losses are reported only on the shareholders' personal returns. Although most states handle S corp. taxation like the IRS, some impose taxes on the businesses, as well.
A limited liability company is a blend of a corporation and partnership. While the business has the legal responsibility for any problems, it does not pay federal taxes. Its owners, or "members," do. However, some states tax LLCs. A single individual or two or more people, corporations or LLCs can own a limited liability company. Each state has its own rules for setting up the business, which involves choosing a name, submitting documents and acquiring licenses or permits.
Perhaps no other decision you make when establishing a business has as much of an overall impact as choosing which structure to use. In addition to determining how to distribute start-up costs, taxes, profits and losses, responsibilities and liabilities, think about your stress level. Do you want the pressure to succeed on your back alone, or do you want others to help carry the burden?