Forms of Business Ownership
When deciding on how your business should be set up, you should consult an accountant and an attorney. You must examine long-term business goals, the amount of control you want to have, whether or not you want formalities, the business’s vulnerability to lawsuits, tax implications, how much profit or loss you expect the business to have, if you need to re-invest earnings into the business, and whether you will need to get cash from the business for personal reasons.
Sole Proprietorships
This is the most basic structure and usually tends to be the traditional way that most small businesses begin. You are the only person running and managing the business, making 100 percent of the decisions. You get all of the income that the business generates and those profits go to your personal tax return. This is also the easiest structure to dissolve if you so choose.
However, there are some drawbacks to being a sole proprietor. Because you are the only one with control of the business, your liability has no limit and if the company goes into debt or gets sued, your business and your personal assets are at risk. Additionally, it is typically more difficult for a sole proprietor to get the funds needed so you may be restricted to using only personal savings or consumer loans. You also may not be able to deduct certain employee benefits like the owner’s medical insurance premiums. Finally, because of the small size of your operation, you will most likely have difficultly getting high-caliber employees to work for you.
There are many federal tax forms that you will most likely need, including Form 1040: Individual Income Tax Return; Schedule C: Profit or Loss from Business (or Schedule C-EZ); Schedule SE: Self-Employment Tax; Form 1040-ES: Estimated Tax for Individuals; Form 4562: Depreciation and Amortization; Form 8829: Expenses for Business Use of your Home; Employment Tax Forms.
Partnerships
A partnership consists of two or more individuals who jointly share a business’s ownership. They are usually popular because it is not very complicated to set up and requires little paperwork other than a recommended partnership agreement. Also, it is usually more successful because the more people involved, the more skills and resources the business will have. In a partnership, any profits that the business derives go directly through to the partners’ personal tax returns and it is often easy to attract potential employees by giving them an incentive to eventually become a partner.
In most cases, the partners will draft and sign a legal agreement between them that details how they will make decisions, share disputes, and resolve disputes. They also detail how partners can be bought out and how the partnership will be dissolved if they desire to do so. During this drafting period, it is also recommended that each of the partners decide how much time and money they will invest. Unless it is otherwise stated in the Partnership Agreement, it is assumed that the partners equally share the profits.
However, a partnership does have its problems. For example, because all of the partners are considered one entity that runs the business, each of the partners are jointly and individually liable for the actions of the other partners. Also, because of the shared nature of the business, partners have to share profits and disagreements are usually more likely to occur. Finally, the partnership is dissolved and would have to be reformed if desired if one of the partners withdraws from the partnership or dies.
What Type of Partnership Should I Consider?
In a general partnership, the partners have to divide management responsibility, liability, and shares of profit or loss in the terms that their Partnership Agreement sets forth.
In a limited partnership or partnership with limited liability, the partners’ liability and input on business decisions is directly proportional to how much they have invested in the company.
Joint venture works as a general partnership, but it is either restricted to a period of time or to a single project. If the partners continue after the period of time is completed, they will be recognized as an ongoing partnership and will have to file the necessary paperwork and distribute the partnership assets accordingly when the entity dissolves.
What Tax Forms Will I Need?
You will need several different tax forms for a partnership, some of which may include Form 1065: Partnership Return of Income; Form 1065 K-1: Partner’s Share of Income, Credit, Deductions; Form 4562: Depreciation; Form 1040: Individual Income Tax Return; Schedule E: Supplemental Income and Loss; Schedule SE: Self-Employment Tax; Form 1040-ES: Estimated Tax for Individuals; Employment Tax Forms
Corporations
A corporation is considered to be a unique entity under law because it has a life of its own and is separate and apart from those who own it. The corporation does not change when ownership changes. The corporation is also an entity that can be sued and the shareholders would only have limited liability, usually only being held accountable for their stock investment of the company. A corporation has to be incorporated in the state in which its headquarters are located. A corporation’s owners are its shareholders and they are responsible for electing a board of directors to oversee the major policies and decisions. Corporations can also sell stock and deduct the cost of benefits provided to officers and employees. Finally, if certain requirements are met, they can be taxed like a partnership if they elect themselves as an S corporation.
However, there are downsides to a corporation. Incorporating a business requires a complicated procedure and a great deal of paperwork, which will require more time and money. There is also more paperwork once the corporation is formed because a corporation is constantly monitored at the federal, state, and local levels. The corporation may also pay double the amount of taxes because they cannot deduct dividends paid to shareholders, making that income taxable twice.
For a regular or “C” corporation, you will need several different tax forms, some of which may include Form 1120 or 1120-A: Corporation Income Tax Return; Form 1120-W: Estimated Tax for Corporation; Form 8109-B Deposit Coupon; Form 4625 Depreciation; Employment Tax Forms; other forms as needed for capital gains, sale of assets, alternative minimum tax, etc.
Subchapter S corporations consist solely of a tax election which allows the shareholder to treat earnings and profits as distributions through their personal tax return. If a shareholder works for a company that makes a profit, the shareholder must pay herself wages under “reasonable compensation” standards, which vary, but basically require you to pay yourself the same amount you would pay an employee to do your job.
You will need several federal tax form for a Subchapter S corporation, some of which may include Form 1120S: Income Tax Return for S Corporation; 1120S K-1: Shareholder’s Share of Income, Credit, Deductions; Form 4625 Depreciation; Employment Tax Forms; Form 1040: Individual Income Tax Return; Schedule E: Supplemental Income and Loss; Schedule SE: Self-Employment Tax; Form 1040-ES: Estimated Tax for Individuals; and other forms as needed for capital gains, sale of assets, alternative minimum tax, etc.
Limited Liability Company (LLC)
This is a recent business structure that is allowed in most states. It is a hybrid of structures, providing the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. It is more complex and formal in its structure and formation. In order to qualify as an LLC, it must not have more than two of the four characteristics that define corporations: (1) limited liability to the extent of assets; (2) continuity of life; (3) centralization of management; and (4) free transferability of ownership interests.
An LLC is taxed as a partnership in most cases, but corporation forms must be used if more than two of the four corporate characteristics described above are met.
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