How To Choose A Legal Structure For Your Business

Getting your business structure right is one of the most important decisions you will make as a business owner. The kind of business structure you choose will determine the income tax return form you will have to file. Although there are many business structures, the most popular types of business are the corporation, partnership, sole proprietorship, and S corporation. State statutes allow the formation of a limited liability company (LLC), whether you’re starting an LLC in Florida or California. There are various legal and tax considerations that you have to take note of when choosing a business structure.

Corporation

A corporation is formed when prospective shareholders exchange money, property or both, for a share of the company’s capital stock. Generally, a corporation makes the same deductions as a sole proprietorship when determining its taxable income. It can, however, also take special deductions.

In terms of federal taxes, a C corporation is a unique entity. It exists to conduct business, earn profits (or losses), pay tax and distribute dividends to its shareholders.

The corporation’s profits are taxed when earned, and then the dividends distributed to shareholders are taxed as well. This is known as double tax. So, the corporation cannot get a tax deduction for distributing dividends and shareholders cannot get any deductions based on any losses suffered by the corporation.

Limited Liability Company (LLC)

An LLC is permitted under state statute. Each state has different regulations surrounding LLCs.  So, if you want to know what regulations apply to your LLC, you will have to check with your state.

An LLC is owned by its members. Ownership is usually not restricted, so any entity can be a member of an LLC. There is no limit to the number of members an LLC may have. Many states allow you to form a “single-member” LLC, which are composed of one owner. Some businesses cannot form LLCs, for instance, banks and insurers. Regulations vary according to your state.

If you want to start a holding company, the most popular business types are the corporation and the LLC.

Partnerships

As the name suggests, partnerships are commercial relationships between two or more persons. Each partner contributes labor, money, property, or skill and participates in both the profits and the losses of the partnership. Though it files an annual report, it does not pay income tax. As a pass-through entity, not only are profits and losses passed through to the partners, so are tax obligations.

S Corporations

S corporations pass through their credits, deductions, income and losses to their shareholders. The shareholders report this flow-through on their personal tax returns and their tax rate is determined by their individual income tax bracket. Consequently, S corporations avoid double taxation.

Sole Proprietorships

A sole proprietor is a person who is the sole owner of an unincorporated business.  A single member domestic LLC, however, is not a sole proprietorship if it elects to be treated as a corporation. A sole proprietorship business structure makes no distinction between the business and the owner. The owner participates in all the profits of the business, but the owner is also responsible for all the business’ liabilities. In other words, the owner is personally liable for the business’ liabilities.