Business Structure

CHOOSING A BUSINESS STRUCTURE!

Sole Proprietorship

A sole proprietorship is the most common form of business organization. It’s easy to form

and offers

complete control to the owner. It is any unincorporated

business owned entirely by one individual. In general, the owner is also personally liable for

all

financial obligations and debts of the business. (State law

may also govern this area depending on the state.)

Sole proprietors can operate any kind of business. It must be a business, not an investment

or hobby.

It can be full-time or part-time work. This includes

operating a: Shop or retail trade business, Large company with employees, Home based

business,

One person consulting firm

Every sole proprietor is required to keep sufficient records to comply with federal tax

requirements

regarding business records.

Generally, sole proprietors file Schedule C or C-EZ, Profit or Loss from Business, with their

Form

1040. Sole proprietor farmers file Schedule F, Profit or

Loss from Farming. Your net business income or loss is combined with your other income

and

deductions and taxed at individual rates on your personal tax

return.

Sole proprietors must also pay self-employment tax on the net income reported on Schedule

C or

Schedule F. You may also be able to deduct one-half of SE

tax on your 1040. Use Schedule SE, Self-Employment Tax, to compute this tax.

Sole proprietors do not have taxes withheld from their business income so you will generally

need to

make quarterly estimated tax payments if you expect to

make a profit. These estimated payments include both income tax and self-employment

taxes for

Social Security and Medicare.

Partnership

A partnership is the relationship existing between two or more persons who join to carry on a

trade or

business. Each person contributes money, property, labor

or skill, and expects to share in the profits and losses of the business.

A partnership does not pay any income tax at the partnership level. Partnerships file Form

1065, U.S.

Return of Partnership Income, to report income and

expenses. This is an information return. The partnership passes the information to the

individual

partners on Schedule K-1, Partner’s Share of Income, Credits, and Deductions.

Partnerships are

often referred to as pass-through or flow-through entities for this reason.

Each partner reports his share of the partnership net profit or loss on his personal Form

1040 tax

return. Partners must report their share of partnership

income even if a distribution is not made.

Partners are not employees of the partnership and so taxes are not withheld from any

distributions.

Like sole proprietors, partners generally need to make

quarterly estimated tax payments if they expect to make a profit.

General partners must pay self-employment tax on their net earnings from self employment

assigned

to them from the partnership. Net earnings from self- employment include an

individual’s share,

distributed or not, of income or loss from any trade or business carried on

by a partnership. Limited

partners are subject to self-employment tax only on guaranteed

payments, such as professional fees

for services rendered.

Corporation

A corporate structure is more complex than other business structures. It requires complying

with more

regulations and tax requirements. It may require more tax

preparation services than the sole proprietorship or the partnership.

Corporations are formed under the laws of each state and are subject to corporate income

tax at the

federal and generally at the state level. In addition,

any earnings distributed to shareholders in the form of dividends are taxed at individual tax

rates on

their personal tax returns.

The corporation is an entity that handles the responsibilities of the business. Like a person,

the

corporation can be taxed and can be held legally liable for its

actions. If you organize your business as a corporation, you are generally not personally

liable for the

debts of the corporation. (Exceptions my exist under

state law.)

When you form a corporation, you create a separate tax-paying entity. Unlike sole proprietors

and

partnerships, income earned by a corporation is taxed at

the corporate level using corporate tax rates. Regular corporations are called C corporations

because

Sub chapter C of Chapter 1 of the Internal Revenue Code

is where you find general tax rules affecting corporations and their shareholders.

A corporation files Form 1120 or 1120-A, U.S. Corporation Income Tax Return. If a

shareholder is an

employee, he pays income tax on his wages, and the

corporation and the employee each pay one half of the social security and Medicare taxes

and the

corporation can deduct its half. A corporate shareholder

pays only income tax for any dividends received, which may be subject to a dividends-

received

deduction.

Sub chapter S Corporation

The Sub chapter S corporation is a variation of the standard corporation. The S corporation

allows

income or losses to be passed through to individual tax

returns, similar to a partnership. The rules for Sub chapter S corporations are found in Sub

chapter S

of Chapter 1 of the Internal Revenue Code.

An S corporation has the same corporate structure as a standard corporation. It is a legal

entity,

chartered under state law, and is separate from its shareholders

and officers. There is generally limited liability for corporate shareholders. The difference is

that the

corporation files an election on Form 2553, Election by a

Small Business Corporation, to be treated differently for federal tax purposes.

Generally, an S corporation is exempt from federal income tax other than tax on certain capital

gains

and passive income. It is treated in the same way as a

partnership, in that generally taxes are not paid at the corporate level.

An S corporation files Form 1120S, U.S. Corporation Income Tax Return for an S Corporation.

The

income flows through to be reported on the shareholders’

individual returns. Schedule K-1, Shareholder’s Share of Income, Credits and Deductions, is

completed with Form 1120S for each shareholder. The Schedule

K-1 tells shareholders their allocable share of corporate income and deductions.

Shareholders must

pay tax on their share of corporate income, regardless of

whether it is actually distributed.

Limited Liability Company

A Limited Liability Company (LLC) is a relatively new business structure allowed by state

statute.

LLCs are popular because, similar to a corporation, owners generally have limited personal

liability for

the debts and actions of the LLC. Other features of

LLCs are more like a partnership, providing management flexibility and the benefit of pass-

through

taxation.

Owners of an LLC are called members. Since most states do not restrict ownership,

members may

include individuals, corporations, other LLCs and

foreign entities. Most states also permit “single member” LLCs, those having only one owner.

A few types of businesses generally cannot be LLCs, such as banks and insurance

companies.

Check your state’s requirements and the federal tax

regulations for further information. There are special rules for foreign LLCs.

For additional information on the kinds of tax returns to file, how to handle employment taxes

and

possible pitfalls, refer to Publication 3402, Tax Issues for

Limited Liability Companies.

COLONIAL ACCOUNTING, INC
ACCOUNTING SERVICES

We will work closely work you to manage every aspect of your financial needs.

All businesses must file an

annual return. The form

you use depends on how

your business is

organized. Sole

proprietorships and

corporations file an

income tax return.

Partnerships and S

Corporations file an

information return. For an

LLC with at least two

members, except for some

businesses that are

automatically classified as

a corporation, it can choose

to be classified for tax

purposes as either a

corporation or a

partnership. A business

with a single

member can choose to be

classified as either a

corporation or disregarded

as an entity separate from

its owner, that is, a

“disregarded entity.” As a

disregarded entity the LLC

will not file a separate

return instead all the

income or loss is reported

by the single

member/owner on its

annual return.

The answer to the question

“What structure makes the

most sense?” depends on

the individual

circumstances of each

business owner.