Structuring Your Business: A Guide to Selecting the Right Choice for You
By: Nathan Cacka, CPA, Financial Advisor & Manager
All individuals pursuing the dream of exercising their entrepreneurial muscles, will face the same question, “Which business structure should I adopt?” The business structure you choose will influence your day-to-day operations and how much you’ll pay in taxes, so it’s critical to consider each option’s pros and cons. Here’s a look into the several choices. I also recommend consulting your tax professional and financial advisor before selecting the type you think is best for your business type.
This structure can be seen as the simplest, but it creates no separation from its owner. Income from the business is simply added to your personal tax return. You are automatically considered to be a sole proprietor if you do business activities but don’t register as any other kind of business. It’s important to note that owners are personally liable for the business’s financial obligations, thus exposing your personal assets (house, savings, etc.). It does not offer a corporation or LLC’s prestige or sense of permanence. This can be a great option for business owners who are just starting out and looking to test their business concept before forming a more formal business structure.
A partnership involves two or more owners. Each person involved contributes their own money, property, labor, and/or skill, and they assume shared profits and losses for the business based on agreed upon allocation percentages. A partnership requires a partnership agreement document and must file an annual information return to report the income, deductions, gains, losses, etc., from its operations, but it does not pay income tax. Instead, it “passes through” profits or losses to its partners. Each partner reports their share of the partnership’s income or loss on their personal tax return. Partners are not employees and shouldn’t be issued a Form W-2. The partnership must furnish copies of Schedule K-1 (Form 1065) to the partner. Partnerships can be a wise choice for businesses that have multiple owners or for professional groups, like attorneys or a family business.
A C-corporation is a separate legal entity from its owners, making it easier to raise money, issue stock, and transfer ownership. Its life is perpetual and will survive the owner’s death. There may be tax advantages, including more allowable business expenses, and protects owners from personal liability for the company’s financial obligations. Profits for a corporation are taxed to the corporation when earned and then is taxed to the shareholders when distributed as dividends, which creates a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders and shareholders cannot deduct any loss of the corporation.
Limited Liability Company (LLC)
An LLC is a hybrid between a corporation and a sole proprietorship, offering easy management, pass-through taxation, and the liability protection of a corporation. Similar to a corporation, it is a separate legal entity, but there is no stock. LLCs provide the protections of a corporation but are taxed similarly to a sole proprietorship. A domestic LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and affirmatively elects to be treated as a corporation. For income tax purposes, an LLC with only one member is treated as an entity disregarded as separate from its owner unless it files Form 8832 and elects to be treated as a corporation. However, for purposes of employment tax and certain excise taxes, an LLC with only one member is still considered a separate entity.
After forming a corporation or LLC, an owner may elect an “S-Corporation Status” by adopting a resolution to that effect and submitting Form 2553 to the IRS. The S-corporation is taxed like a partnership, i.e., the company’s income will pass through to shareholders and be reported on their respective personal tax returns. S-corporations avoid the double taxation issue associated with C-corporations while enjoying many of the same tax advantages. Owners are shielded from personal liability for the company’s financial obligations. However, S-corporations do not have all the tax-deductible expenses of a C-corporation. The cost of set up, the paperwork, and the formality are greater than for a sole proprietorship or LLC. S-corporations have certain restrictions, including a “100 or fewer” shareholders requirement. Shareholders must be U.S. citizens, and the business cannot be owned by another business.
Remember, the choice of business structure is not an irreversible decision. You may amend your business structure to accommodate your changing needs and circumstances. It’s imperative you consult a tax professional and financial advisor who can provide extensive transaction experience, in-depth market intelligence, and proprietary information relevant to your new business.
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