Deciding on a Business Form

Sole Proprietorships
This is a business owned by one individual who is responsible for all debts of the business. The net income of the business is included in the owner’s taxable income on his personal tax return by filing Schedule C.

• Advantages: Legal and filing fees are minimal, less regulation and paperwork, and taxes may be lower than for a regular corporation.
• Registration: Most cities and many counties require home-based sole proprietorships to register with them, particularly if doing business under a name other than the owner’s.
• Liability: Unlimited liability for all business debts incurred, meaning that the owner’s personal property may be taken to cover business debts.
• Self-employment Tax: The net income of the business is subject to self-employment tax for Social Security and Medicare contributions at a current rate of 15.3% if the net earnings were $400 or more. Half of the SE tax can be deducted in figuring adjusted gross income on your personal income tax return. Sole proprietors must also pay quarterly estimated income taxes to the IRS if they expect to owe tax, including SE tax, of $1,000 or more. Nonpayment of estimated taxes will result in penalties when the personal income tax return is filed.
• Losses: If the business owner is an active participant, its losses are fully deductible against other individual income.

PARTNERSHIPS
This is a legal entity that is jointly owned by two or more individuals, corporations or other entities.

• Advantages: Few filing fees and franchise taxes, more flexible management than in a corporation, and some possible tax advantages because double taxation of corporations is avoided.
• Liability: Unlimited liability in a “general” partnership. In a “limited” partnership, the partners are liable only to the extent of their individual investment.
• Self-employment Tax: In a “general” partnership, the partners are subject to self-employment tax. “Limited” partners are not subject to this tax unless they receive guaranteed payments for services performed within the partnership. Partners must make quarterly estimated income tax payments on their share of the partnership income, unless the partnership loses money and makes no distributions.
• Losses: In most instances, partners can deduct losses against other income, up to their tax basis in the partnership and based on their amount of risk.

LIMITED LIABILITY COMPANIES
This is a business entity that is similar to a corporation that offers limited personal liability to its owners, and yet offers tax advantages to its owners as in a partnership. The entity is dissolved when a member dies or undergoes bankruptcy. Must file Articles of Organization with the Secretary of State, and most states require an Operating Agreement.

• Advantages: No double taxation as in a corporation, no required formal minutes or resolutions, little paperwork and recordkeeping, and it is fairly inexpensive to establish as well as paying the annual registration fees.
• Liability: Personal liability is limited for the partners in that all personal assets of the partners are protected from creditors of the corporation.
• Self-employment Tax: Except for some specific situations, the LLC members are subject to self-employment tax.
• Losses: If the LLC is taxed as a partnership, the losses can be deducted against other income.

“S” CORPORATIONS
This is also referred to as a Small Business Corporation and is not a tax-paying entity. It is a legal entity wherein which its income, deductions, credits and losses are passed onto the shareholders, who in turn pay whatever tax is owed. These types of corporations are formed as a tax strategy for small-business owners, but it is not recommended in all cases and should be discussed with a professional. Must have annual meetings with formal minutes and recorded resolutions.

• Advantages: No double taxation as in a regular corporation and it is good for start-up ventures that are expected to operate at a loss for the first couple of years.
• Liability: The owners are not personally liable for debts and obligations of the corporation.
• Self-employment Tax: The income flowing through to the shareholders based on their shares of the corporation are not subject to self-employment tax.
• Losses: Losses up to their tax basis in the corporation may be deducted by shareholders on their individual tax returns based on their proportionate share of the corporation.

“C” CORPORATIONS
This is a legal entity owned by one or more persons and having rights and responsibilities of its own, independent of the owners and operators. Must have annual meetings with formal minutes and recorded resolutions.

• Advantages: It is easier to raise capital than other forms of ownership and the ownership of shares is more easily transferable. It also doesn’t stop existing just because one of the shareholders dies or retires. They can choose a fiscal tax year, and they can deduct contributions to charities.
• Disadvantages: Double taxation: tax on the corporation and a tax on the dividends paid to the shareholders. Liquidation or sale of the corporate assets will result in double taxation to the shareholders, if there is a taxable gain.
• Liability: The owners are not personally liable for debts and obligations of the corporation.
• Self-employment Tax: Does not apply.
• Losses: Deductible to the corporation only