The legal structure of your new business will determine the income tax form you will file. There are four basic taxes levied by the federal government: Income Tax, Self-Employment Tax, Taxes for Employers, and Excise Taxes.
To learn more about small business taxes you can visit the IRS website.
The information that follows in this section only serves as a brief introduction to help you begin the process and is in no way a substitute for professional advice.
When you are considering the business entity you will form, you can begin by considering the following:
- The size and nature of your business
- The number of equity owners
- The tax implications for your business
- The formality and level of structure you are willing to work with
- The business’s vulnerability to lawsuits
- The ease of transfer you wish your business to have to a family member, employee or outside purchaser.
- The business’s expected profit or loss
- The need for re-invested earnings
- The desired amount of personal liability
- The options for generating capital
This is the simplest kind of business structure to establish and most small businesses start out as sole proprietorships. It is run by the individual without outside investors, which is why the business owner is then called the sole proprietor. The business becomes an extension of the business owner.
- Easiest and least expensive type of business ownership
- The sole proprietor is in complete control, within the legal parameters, to make decisions
- Profits and losses flow through the owner’s personal tax return
- Easy to dissolve
- Terminated at death of the proprietor
- The proprietor has unlimited liability that extend to the actions of employees or agents acting on behalf of the proprietor. They are liable for business related debt and it may place personal assets at risk.
- Can be difficult for raising funds and many times are limited to using funds from personal savings or consumer loans u May be difficult to attract talent with experience in larger companies or organizations
- All the demands of running the business fall on the shoulders of the sole proprietor
A general partnership is when two or more persons enter into an agreement to share ownership and operate a business together.Like a Sole Proprietorship the owners are liable for the business, and there is little distinction between business and owner.
While a formal written agreement is not necessary when forming a partnership, it is strongly advised; otherwise any dispute will be settled according to the law of the state where the partnership is primarily located.
- They are relatively easy to establish
- There are no taxes paid at the business level, instead the individual partners are taxed on the income they receive from the business.
- The partnership may have a limited life, depending on the agreement made by the partners
- Each partner is jointly or severally liable for any business debt or claim like a sole proprietorship
Limited Partnership (LP) and Partnership with Limited Liability (LLP)
A Limited Partnership is more complex and formal than general partnerships. What determines the liability is contingent on the involvement of the partner.
General partners are those who will assume control of the business including the day to day operations while limited partners are those whom have contributed or invested in the partnership but retain no control of the function of the partnership outside of the decision involving the dissolution of the partnership.
A Partnership with Limited Liability (LLP) is very similar to a general partnership, but with more liability protection for the partners. They are formed by filing a Certificate of Partnership with the appropriate state office, but not all states recognize these partnerships and others limit them to professional groups.
A corporation is a business entity that is wholly separate from the shareholders who own it and considered by law its own entity. It will not dissolve when ownership changes.
As its own entity it can be taxed, sued, or enter contractual agreements. The owners of the corporation are the shareholders who in turn elect a board of directors to oversee major changes or decisions.
- A corporation has a separate legal and tax life.
- A corporation will pay its own tax rates and file taxes annually.
- Management and control are run by a board of directors.
- Authority for day to day operation is usually delegated to officers and employees.
- Shareholders are the owners of a corporation.
- A corporation may be formed and operated by one or more persons.
- The process of becoming a corporation takes more time and money than other forms of business entities.
- A corporation is monitored on the federal, state, and local level often requiring a lot of paperwork.
- A corporation may also be formed by one or more business entities.
- A corporation is also responsible for federal and state income taxes.
Sub-Chapter S-Corporation (Entities Taxed as S-Corporations)
An S-Corporation is different from a C-Corporation in that profits and losses are filed through the shareholder’s personal tax return. The designation of an S-Corporation is created through an IRS tax election. The business remains its own separate entity limiting the owner’s personal liability.
- The business must first file a corporation application at the state level.
- Shareholders must be either US Citizens or Permanent Resident Aliens.
- A strict operational process is required that includes scheduled director and shareholder meetings, minutes, records, maintenance and so forth.
- The maximum number of shareholders is 100
- Must have one class of stock
- LLC’s may also elect to be taxed as S-Corporations in the same manner as corporations.
Limited Liability Company (LLC)
A Limited Liability Company is a hybrid of the operational flexibility and tax efficiencies of a partnership with the limited liability of a corporation. The life of an LLC is determined by the date the paperwork is filed. The owners of an LLC are called members and can be one or more persons, corporations, another LLC or even other entities.
- A member’s liability is limited to personal investment in the business.
- Tax and liability administration is not the same across state lines.
- They are easier to form than other types of corporations but more complex than partnerships.
- An operating agreement may not be required by your state but, it is highly recommended for multi-member LLCs.
Each of these types of structure has its own advantages and disadvantages, so you should explore the explanations of each corporation type and consult a tax accountant for advice.
Looking for a reliable, experienced and knowledgeable Tax Accountant that help with your small business?
Miami Mompreneur Yamaris Diaz is a Certified Tax Coach and Certified Public Accountant specializing on Small Businesses and E-commerce.
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