Starting a business involves a great deal of decision making. One of the first, and most important, decisions is choosing a business structure. A business structure can affect how much you pay in taxes, the paperwork you are required to file, and your personal liability as the business owner. The options for common business structures are as follows –
Sole Proprietorship
A sole proprietorship is an unincorporated business with only one member, meaning the business is not a separate legal entity, and therefore, does not require a separate business return. However, as a sole proprietor, you can be held personally liable for the business’ debts and obligations. Profits of a sole proprietorship are taxed as earned income on the individual’s personal income tax return, and losses may in certain circumstances be used to offset other income. Additionally, a sole proprietorship is subject to self-employment tax.
Single Member LLC
A single member LLC is similar to the sole proprietorship in that it has only one member and is taxed on the individual’s personal income tax return, however, it is a separate legal entity. The benefit of a single member LLC is the protection it generally provides a business owner from personal liability of the debts and obligations of a business.
Partnership
A partnership is a separate legal entity with two or more owners. For tax filing purposes, a partnership is referred to as a pass-through entity, meaning the business’ profit and losses are passed through to the individual partners. The partnership is required to file a business informational return (Form 1065) which issues a Schedule K-1 to each partner, reporting their individual share of profit and losses, which is then reported on their individual income tax return. Since the partners are individually responsible for any tax liabilities, the partnership itself is not subject to separate business taxes. Personal liability of a partner is dependent upon the type of partnership formed. A limited partnership (LP) has at least one general partner with unlimited liability and the remaining partners have limited liability. A limited liability partnership (LLP) provides limited liability to all partners.
Corporation: S Corp
An S Corp is a separate legal entity with one or more owners. Unlike partnerships, a business must file an election with the IRS in order to obtain S Corp status. S Corps, similar to partnerships, are pass-through entities and must file the business informational return (Form 1120S). The S Corp return issues a Schedule K-1 to each shareholder reporting their share of profit and losses to be reported on their individual income tax return. Generally, there are no separate business taxes for an S Corp. Shareholders are not personally liable for the entity’s debts, unless a personal guarantee is granted.
Corporation: C Corp
A C Corp is a separate legal entity that differs from Partnerships and S Corps in that they are not a pass-through entity, meaning the business’ profits are taxed at the entity level rather than the individual. A C Corp must file a corporate tax return (Form 1120) each year and pay any tax liability. Despite profit and losses not passing through to the shareholders, there is an instance where a C Corp shareholder could be responsible for a tax liability. If profits are distributed to shareholders in the form of a dividend, the individual would report, and be taxed on, the dividend income on their personal income tax return. Stockholders have no personal liability, therefore, they are protected from the entity’s debts, unless a personal guarantee is granted.
A business structure can impact multiple aspects of your business, so it is important to consult with your HK tax professionals and ensure you’re selecting a structure that best suits your future business. Call Courtney at 330-453-7633 for more information.
