Types of business structures. (Information taken from www.irs.gov)
Sole Proprietorship. A sole proprietorship is a one-person business that is not registered with the state like a limited liability company (LLC) or corporation. Legally, a sole proprietorship is inseparable from its owner -- the business and the owner are one and the same. This means the owner of the business reports business income and losses on his or her personal tax return and is personally liable for any business-related obligations, such as debts or court judgments.
Partnerships. Similarly, a partnership is simply a business owned by two or more people that hasn't filed papers (with the Federal Government) to become a corporation or a limited liability company (LLC). You don't have to file any paperwork to form a partnership -- the arrangement begins as soon as you start a business with another person. As in a sole proprietorship, the partnership's owners pay taxes on their shares of the business income on their personal tax returns and they are each personally liable for the entire amount of any business debts and claims.
- Simple, minimal paperwork, low cost, no lawyers needed.
- Can obtain official numbers and resale licenses.
- Take advantages of business expenses and deductions.
- Simple taxes
- Open liability, minimal tax advantages, operating as an extension of you.
LLC (Limited Liability Company) A Limited Liability Company (LLC) is a business structure allowed by state statute. LLCs are popular because, similar to a corporation, owners have limited personal liability for the debts and actions of the LLC. Other features of LLCs are more like a partnership, providing management flexibility and the benefit of pass-through taxation.
Owners of an LLC are called members. Since most states do not restrict ownership, members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Most states also permit “single member” LLCs, those having only one owner.
A few types of businesses generally cannot be LLCs, such as banks and insurance companies. Check your state’s requirements and the federal tax regulations for further information. There are special rules for foreign LLCs.
- Provides more liability for the owner.
- Easier to form than a corporation.
- No Double Taxation
- Simple annual paperwork
- Filing tax as an extension of you, no corporate shares, no corporate name, not all the advantages of a full corporation.
C Corporation. In forming a corporation, prospective shareholders exchange money, property, or both, for the corporation's capital stock. A corporation generally takes the same deductions as a sole proprietorship to figure its taxable income. A corporation can also take special deductions. For federal income tax purposes, a C corporation is recognized as a separate taxpaying entity. A corporation conducts business, realizes net income or loss, pays taxes and distributes profits to 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 creates a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any loss of the corporation.
- Considered a completely separate entity.
- Ideal for large business.
- Easiest to sell stock.
- Double taxation, expensive to start and maintain legally, lots of annual and quarterly paperwork.
S Corporation S corporations are corporations that elect to pass corporate income, losses, deductions and credit through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income.
To qualify for S corporation status, the corporation must meet the following requirements:
- Be a domestic corporation
- Have only allowable shareholders
- including individuals, certain trust, and estates and
- may not include partnerships, corporations or non-resident alien shareholders
- Have no more than 100 shareholders
- Have one class of stock
- Not be an ineligible corporation i.e. certain financial institutions, insurance companies, and domestic international sales corporations.
- Operates as a corporate entity and viewed as a corporation.
- Almost all corporate advantages.
- Considered most tax friendly.
- Expensive to start and maintain legally, lots of annual and quarterly paperwork, restrictions limit size and stock holders, cannot take public, still a paper trail through to the stock owners.
Note, you can convert an S Corp into a C Corp when your business grows to a point where that is necessary.