How Business Structure Affects Taxes

How Business Structure Affects Taxes

Pick Your Poison

What type of business do you have/want/plan to make?

Sole Proprietorship: The one man show
Partnership: The dynamic duo
Limited Liability Corporation: Something you can get behind
Cooperative: By the people for the people
C Corporation: The big money makers
S Corporation: LLC plus

The choice can be important when it comes to taxes.

Sole Proprietorship

There is no distinction between you and the business.
You are entitled to all profits
And responsible for all business
And Liabilities

Business and personal taxes are not separate.
Because sole proprietorship income is your income.
Schedule C
And Form 1040
Additional Requirements:
Self-employment tax: the portion of social security and medicare tax paid by an employer.
Estimated taxes: the method through which one pays self-employment taxes throughout the year.

Lowest tax rates of business structures
Quick and Inexpensive to form
You have complete control over your business
Only file taxes Once

Unlimited personal liability
Hard to raise money

There are many more sole proprietorships than any other form of business:

Number of registered businesses by type:
Sole Proprietorship: 22.6 million
Corporations: 5.8 million
Partnerships: 3.1 million

Yet corporations account for a vast majority of income:

Net income by business type:
Sole Proprietorship: $265 billion
Partnerships: $458 billion
Corporations: $984 billion



2 of more people share ownership
Sharing profits and losses

3 Types:
General Partnerships:
Equal division in profits, liability, and management.
Limited Partnerships:
Limited liability and input allocated depending on a partner's share of ownership.
Joint Ventures:
Time limited general partnership (above).

Partners must file a return of income for their business
And file taxes personally on their share of income or losses.

Quick and inexpensive to form
Easy to acquire funding
Number of partners can change over time

Lack of complete control for an individual
Personally liable for debt of other partners
Disputes between partners are common

Limited Liability Company

Hybrid between a corporation and a partnership
Owners are called "members"
Which can be a single individual
A partnership
Or Many members
Profits and Losses are "passed through" to members.

Setting one up:

1.) Choose a name
2.) File Articles of Organization
3.) Create an operating agreement
4.) Obtain Licenses and Permits
5.) Announce your business (in some states)
Then: Prosper!

Partners file taxes on their personal returns
But several states require additional state taxes.
Personal Tax Forms
Or, Form 8832 to file as a business

Limited liability of a corporation
Operational flexibility of a partnership
Easier to raise money
Fewer restrictions on profit sharing
Surplus earnings not taxed

Subject to self-employment tax
Leaving members can dissolve LLC in some states


Coop's are entities operated by those they service
Members purchase shares to gain voting rights
Profits are distributed among members

Setting one up:
1) File articles of incorporation
2.) Create bylaws
3.) Create a membership application
4.) Create Charter Member Meeting and Elect Leaders
5.) Obtain Licenses and Permits

Operates as a corporation but "passes through" income to members
Individual members pay personal taxes on cooperative gains
Some Coop's like Credit Unions or Rural Utility Coop's are tax exempt

Personal tax forms
3491 Consumer Cooperative Exemption Application

Surplus earnings not taxed
Many government-sponsored grant opportunities
Perpetual existence
Democratic in nature
One-member one-vote often stops large investors
Reliant on members

C Corporation

A separate legal entity owned by shareholders
Corporation shields owners from legal and monetary liability

Setting one up:
1.) Choose a name
2.) File articles of incorporation
3.) Hire a director and issue stock (in some states)
4.) Obtain business licenses and permits

Corporations are required to pay federal, state, and sometimes local taxes
Profit is subject to income tax
–>leading to double taxation at times
First when the corporation makes a profit
And twice when dividends are paid to shareholders

Corporations pay half of employee social security and medicare taxes
or 1120-A


Limited liability
Ability to generate capital
Corporate taxes often lower than personal taxes

Time and money, are spent on start-up and administrative costs
Double taxing, in some cases
Additional Paperwork
Less control for individuals

S Corporation

S Corporations allow profits and losses to be passed through to personal tax returns
Avoiding double taxation
Only shareholders are taxed when dividends are paid.

Setting one up:
1.) File as a C Corporation
2.) Qualify for S Corporation Status
3.) All shareholders must file an IRS form 2553

Owners treat taxes as they would for a partnership or sole proprietorship.
Shareholders are taxed when dividends are paid.
Remaining income paid to owner as "distribution," which is taxed at a lower rate.

Limited Liability
Tax savings
Shareholders separate from company.


Stricter operational processes
Shareholder Compensation requirements
Foreign ownership of shares is prohibited
More than 100 shareholders is not permitted