Selecting Your Business Structure
When beginning a business, you must decide what form of business entity to establish. The type of business entity determines which income tax return you have to file. The most common forms of business are the sole proprietorship, partnership, and corporation. A Limited Liability Company is a relatively new business structure allowed by state statute.
Legal and tax considerations enter into selecting a business structure.
A sole proprietor is someone who owns an unincorporated business by himself or herself. However, if you are the sole member of a domestic Limited Liability Company, you are not a sole proprietor if you elect to treat the Limited Liability Company as a Corp.
In forming a corporation, prospective shareholders exchange money, property, or both, for the entity capital stock. A corp generally takes the same deductions as a sole proprietorship to figure its taxable income and can can also take special deductions. For federal income tax purposes, a C corp is recognized as a separate taxpaying entity. A corp conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders.
The profit of a corp is taxed to the entity when earned, and then is taxed to the shareholders when distributed as dividends. This creates a double tax. The business does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any loss of the entity.
S corp are business entities that elect to pass corporate income, losses, deductions and credit through to their shareholders for federal tax purposes. Shareholders of S corp report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corp to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income.
To qualify for S corp status, the entity must meet the following requirements:
1. Be a domestic corporation.
2. Have only allowable shareholders including individuals, certain trust, and estates and may not include partnerships, corp or nonresident alien shareholders.
3. Have no more than 100 shareholders.
4. Have one class of stock
5. Not be an ineligible corporation i.e. certain financial institutions, insurance companies, and domestic international sales corporations.
Limited Liability Company.
A Limited Liability Company is a relatively new business structure allowed by state statute.
Limited Liability Companies are popular because, similar to a corporation, owners have limited personal liability for the debts and actions of the Limited Liability Company. Other features of Limited Liability Companies are more like a partnership, providing management flexibility and the benefit of pass-through taxation.
Owners of a LLC are called members. Since most states do not restrict ownership, members may include individuals, corporations, other Limited Liability Companies and foreign entities. There is no maximum number of members. Most states also permit single member LLC, those having only one owner.
A few types of businesses generally cannot be LLC, such as banks and insurance companies. Check your states requirements and the federal tax regulations for further information. There are special rules for foreign LLC.
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