Sole proprietorship, partnership, limited liability company, or a corporation (“C” Corporation or “S” Corporation) are the most widely used choices available. There are also other variations on these classifications. Tax, legal, and estate planning issues play a big role in your decision. Making the wrong choice can cost time and money. Each structure has a different legal and tax status that can be used to your advantage as follows:
A sole proprietorship is usually a small business with few, if any, employees. It is easy to form and there are few restrictions on the flexibility. Profits and losses flow through the proprietor and are reported on his or her personal form 1040 income tax return. There is generally no protection for the sole proprietor against legal liability for the proprietor’s actions or inactions.
Like the sole proprietorship, the partnership’s profits and losses flow through to the partners. In addition, losses can be deducted; however, there are restrictions on the proportion. The disadvantage is the lack of legal protection against legal liability. Each partner is liable for all the partnership debts.
Limited Liability Company
A limited liability company may be taxed like a partnership (i.e. through the individuals). In addition, it offers its members limits to liability from the business’ and the other members’ liabilities.
A corporation is a legal entity having its own assets, liabilities, and privileges apart from those owning or forming the corporation. The corporation can own assets, borrow money, and perform business functions. Corporate earnings, however, are subject to double taxation of profits. A “C” Corporation pays its own income taxes and, when dividends are passed through to shareholders, they too are liable for taxes on that payment. A corporation’s stockholders are generally not liable for corporate debts and liabilities.
If an “S” Corporation qualifies, it may be taxed under a special section of the Internal Revenue Code which permits a corporation to be taxed as a partnership/sole proprietorship, i.e., through the individuals, generally, there is no “double taxation” problem.