Business Tax Entities
There are several factors to consider when owning a business rather than just the income earned. Business owners, partners, and shareholders must ensure that the business remains in good standing. This is due to the stipulations and complications that can occur if the business is out of compliance, which often most certainly affects the bottom line of the company’s operation.
When deciding to establish a business, owners must consider several precautions before formation is completed. One of those being choosing the right tax entity for the business. The tax entity chosen for the business determines the impact that will be felt by the business and the owner(s). Each entity is impacted differently by tax laws and should be chosen carefully based on the appropriateness of the business’s future needs.
Though there are several possible business entities to choose from, there are some that are more common than others, of which will be discussed below. Five common business entities are sole proprietorship, partnership, Limited Liability Company (LLC), C Corporation, and S Corporation. A common mistake made by business owners, which often leads to major tax implications, is choosing the wrong business entity. Let’s dive into each entity.
Sole Proprietorship are considered disregarded entities, of which has the least amount of legal requirement, yet the most risk involved due to no liability protection. Under this entity there is no separation between the business and the taxpayer. All business transactions of a sole proprietorship are reported as part of the taxpayer’s personal tax return on Schedule C or Schedule C-EZ. As a pass-through entity, the profit/loss is assessed at the taxpayer’s level.
Partnerships for legal purposes are classified as either a general partnership or a limited partnership. The major difference between the two status are the liability protection and the tax impact faced by each partner. A general partnership is simply a sole proprietorship with two or more members, of which no legal formation is required. Whereas a limited partnership must perform formal filing with the state, giving them the limited liability coverage they need.
Limited Liability Company (LLC) are the most popular entity chosen by business owners because of the flexibility it allows. LLC provides a separation between the owner and the business allowing them to be impacted by little to no risk if they were to ever be sued by anyone. Each owner of an LLC is referred to as a member. For tax purposes LLCs has the option to elect to be treated as a C-Corporation or S-Corporation. Additionally, if there are more than one-member owner of an LLC it is referred to as a multi-member LLC.
C Corporations are treated as a separate entity from its owner(s), who are referred to as shareholders. This filing entity requires that the business adhere to a much stricter legal filing requirement and maintenance. The loss or profit generated by the corporation does not affect the shareholder, only the business itself.
S Corporations shares similar traits to that of a C Corporation and an LLC and is seen as a very favorable entity due to its flexibility. In the sense that S Corporations are given the luxury of being a separate entity from the shareholder, allowing for complete liability protection from personal assets. While not being subjected to double taxation but being a pass-through entity that is taxed only once at the shareholder level.
Though some business entities may share similar characteristics, they remain unique base on the needs of the business and its owner(s). Therefore, when trying to configure the best entity for your needs, I would recommend performing some sort of research before hand as well as seeking the advice of an accountant.