When beginning a business, you must decide what form of business entity to establish. Your form of business determines which income tax return form you have to file. The most common forms of business are the Sole Proprietorship, Partnership, Limited Liability Company (LLC), Corporation and “S” Corporation. Legal and tax considerations enter into selecting a business structure.
Sole Proprietorship
A sole proprietorship is the form of business entity with the least amount of legal formalities. In a proprietorship, the owner assumes sole responsibility for the operations and finances of the business, including profit and loss. In the proprietorship form of business entity, the owner’s personal property is tied directly to the business; therefore, the owner assumes unlimited risk of his personal assets.
Partnerships
A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.
A partnership 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” any profits or losses to its partners. Each partner includes his or her share of the partnership’s income or loss on his or her tax return.
Partners are not employees and should not be issued a Form W-2. The partnership must furnish copies of Pricing K-1 (Form 1065) to the partners by the date Form 1065 is required to be filed, including extensions.
Limited Liability Company
Forming a limited liability company protects your personal assets by keeping them separate from your business assets, and it provides the greatest flexibility available when it comes to taxation and business structure.
An LLC is the most common choice for small businesses with a single proprietor or a small number of members, as it offers the protections of incorporation without the same requirements necessary for larger, multi-shareholder companies.
S Corporation
S corporations offer specialized taxation that limits the company’s liability. When you form an S corporation, the company itself isn’t taxed. Instead, profits and losses are tallied and taxed after being distributed to shareholders.
For this reason, an S corporation is most often chosen by companies incorporating with multiple shareholders, and is considered a good alternative to legal business partnership because it provides tax benefits without the overhead and complexity.
C Corporation
In C corporations, profits are taxed at the business level before being distributed to shareholders, but the main feature of this type of incorporation is that it offers certain advantages that some companies require.
Specifically, a C corporation is the only option available for US companies choosing to work with foreign investors. Forming a C corporation also allows you more flexibility with shareholder involvement by making it possible to create multiple classes of stock.
Business Entity Incorporation
Corporate Tax Filing
All business entities such as Sole proprietors, Partnerships, Corporations and Limited Liability Companies are required to pay the following taxes.
Federal & State Taxes
A business entity should pay income taxes in the form of Estimated Tax Liability during the year in which the income earned. After the tax year is over, the business should file annual tax returns as follows.
- Sole Proprietorship – File Form 1040 along with Schedule C
- Partnership – File Form 1065 and issue Schedule K-1 to partners
- S Corporation – File Form 1120S and issue Schedule K-1 to shareholders
- C Corporation – File Form 1120
Employment Taxes
A business entity with employees are required to pay employment taxes such as withholding and pay federal & state taxes on the employees pay, paying and reporting FICA taxes ( Social Security tax & Medicare Taxes) and Unemployment Taxes.
Also, a business should file quarterly Federal tax returns – Form 941 and annual FUTA tax return – Form 940 apart from the annual Federal and State tax returns.