There’s a lot riding on your new business venture, and as such, it’s important that you follow all the necessary steps to get it set up properly, which includes selecting the right business structure.
The business structure you choose can have a direct impact on how you calculate your income taxes, and whether you choose sole proprietor or LLC, this will also impact the amount of personal liability you take on. While you can of course hire a tax professional to help you with this, you still need to decide which business entity to set things up under.
To help you with this decision (you can also consult with a business entity management company who will likely have even more up-to-date guidance to give you), here’s a brief overview of the different business structures available to you in the U.S. today:
Sole proprietorships
If your business is unincorporated and owned by you alone, then you are the sole proprietor. As the most straightforward business structure, you’ll be taxed as an individual, and will become personal responsible for all liabilities and losses that might occur.
Partnerships
When two or more individuals engage in a business together, it’s classed as a partnership, with each one making their own contributions, and is known as a pass-through entity. In partnerships, every party involved shares the profits and losses of the business, and these are then reported on their personal tax returns.
C Corporations
Bigger companies with a large number of employees typically use this more complex type of entity, in which money or property are contributed by shareholders in exchange for shares in the businesses capital stock. When the dividends are distributed, shareholders pay taxes and are not subject to personal liability.
S Corporations
There are several requirements of this particular type of entity, such as it having no more than 100 shareholders and one class of stock. Also a pass-through entity, corporate income, credits and losses, and deductions, are passed to the shareholders for the purpose of taxation. All pass-through income and losses are reported by shareholders on their own tax returns, and must pay the appropriate tax at their own personal tax rates.
Limited liability companies (LLCs)
Depending on the state in which your business is operating, there may be different regulations that apply when choosing this particular structure. Members (owners of the business) may be individuals, other LLCs, corporations or foreign entities, but there are certain business types (such as banks and insurance companies, for example) who are not permitted to be members. LLCs are considered by the IRS to be partnerships or corporations.
Understanding the relevant income tax and liability issues associated with the type of business structure you choose, is important, and if you’re doing it for the first time, or want to change your existing business entity to a different one, you should seek professional guidance to avoid making any mistakes that could cost you your business.