Starting a New Business? Make Sure You Choose the Right Entity!
Starting a new business? Make sure your business entity fits your needs. There are six basic entities you can choose from. These six entities are governed by federal and state laws and have varying federal income tax rules.
A sole proprietorship is the simplest form of business. It is owned by one person and is not a separate legal entity. The owner is personally liable for all legal issues or losses that arise from the business. For federal income tax purposes all business income and expenses are reported on Schedule C of the 1040.
If you are starting a venture with someone else, a general partnership may be the way to go. In a partnership the partners agree on how the profits, losses, and liabilities are shared. These agreements can range from a formal document to a verbal agreement. Just like a sole proprietorship the partners are personally liable for the dealings of the business. For income tax purposes each partner receives a K-1 that reports their share of income and expenses. This information is reported on each partner’s 1040.
Does the idea of personal liability make you nervous? Then a C-corporation may be the right entity for you. A C-corporation is a separate legal entity that is owned by its’ stockholders. The stockholders’ personal assets are protected in case of losses or legal issues. A huge disadvantage of this entity is double taxation. C-corporations are taxed as its’ own legal entity, and then that income is taxed again when it is passed out to the shareholders, resulting in double taxation.
If you want to avoid double taxation but keep limited liability, an S-corporation may be a way to go. S-corporations have various restrictions on who can own them. For example S-corporations cannot have more than 100 stockholders and must be domestic. S-corporations are taxed similarly to partnerships. Each stockholder will receive a K-1 reporting their share of income and deductions, which is then reported on each shareholder’s 1040.
Another entity type that offers limited liability and avoids double taxation is a limited liability company (LLC). LLC members’ liability is limited to their investment in the business. LLCs are not a separate entity and can be taxed similarly to a partnership, with each member receiving a K-1.
The final entity option is a not-for-profit. This organization is for those of you who are looking to establish an organization to positively impact society in some way. There are strict limitations on the activities of not-for-profits, and generally these organizations do not pay taxes.