LUTZ BUSINESS INSIGHTS
Sole Proprietor? LLC? Choosing a Business Structure
AMANDA HARPSTER, CLIENT ACCOUNTING SERVICES MANAGER
Your early days as a new business owner are full of decisions, ranging from choosing a name to the font on your business cards. Some can be modified down the road, while others stick.
Choosing a business structure is a little of both. Your choice to function as a sole proprietor or LLC or corporation will have impact on the income tax forms you’ll use and the rules you must follow to be compliant. You can change your structure down the road, but you should select the one that best fits you now and for the foreseeable future.
Both tax and nontax factors will influence your choice of a business structure. Here are some basics of each option.
Sole proprietorship is the simplest structure to operate a business and the most commonly-formed. It also places responsibility for all financial obligations and debts on the owner, though this can vary by state. The sole proprietorship is not a legal entity. It can operate under the owner’s name or it can do business under a trade name.
Sole proprietors, of course, don’t have income taxes withheld; there’s no employer to withhold Social Security and Medicare taxes on the owner’s earnings. The company does not file a separate entity tax return. The business information is reported on a Schedule C or Schedule F of the owner’s Form 1040, individual income tax return and the owner must pay self-employment tax on the net income reported.
A Partnership is a legal form of business operation between two or more participants. Like sole proprietors, general partners are personally liable for the partnership’s obligations and debts. One of the major advantages of a partnership is the tax treatment.
Partnerships are sometimes referred to as “pass-through entities” because of their income tax structure. The partnership itself doesn’t pay any income tax; it reports income and expenses on a Form 1065, which is simply an informational form. The two or more participants who formed the partnership each receive a Schedule K-1 (Partner’s Share of Income, Credits, and Deductions). The owners prepare their respective tax returns using the information from the Schedule K-1 and are required to pay self-employment tax on the Schedule K-1 income.
C – Corporation
C corporations offer liability protection for their owners, also known as shareholders. C corporations are treated as separate taxable entities. They compute their own taxable income and pay the tax on this income. C corporations can have an unlimited number of shareholders. Many entities raising funds prefer C corporations over other structures due to these separations.
However, C corporations are subject to double taxation. In other words, C corporation income is taxed twice – once when earned and once when distributed to the owners of the business. Corporations pay corporate income taxes at the federal level, using the Form 1120.
S – Corporation
While S corporations are corporations for state law, they are taxed much like partnerships for income tax purposes. Like a partnership, the S Corporation itself doesn’t pay any income tax; it reports income and expenses on a Form 1120S, which is simply an informational form. The shareholders of the S corporation receive a Schedule K-1 (Shareholder’s Share of Income, Deductions, and Credits). This information is reported on the shareholder’s Form 1040, individual income tax return. There are restrictions on who can be a shareholder of an S corporation and the entity must formally elect to be taxed as an S corporation.
There are several tax advantages of operating as an S Corporation instead of as a C Corporation. These tax advantages include a single level of tax and the availability of losses passed through to the shareholders. In addition, there are some disadvantages such as fewer tax free fringe benefits to shareholder-employees.
Limited Liability Company (LLC)
Limited Liability Companies, also known as LLCs, are essentially a hybrid entity that combines the characteristics of a corporation and a partnership or sole proprietorship. LLCs offer liability protection for their owners, similar to C and S corporations. The tax efficiencies are offered due to the fact, LLCs are subject to pass-through taxation. An LLC with more than one owner is taxed as a partnership unless an election to be taxed as an S corporation is filed.
ABOUT THE AUTHOR
AMANDA HARPSTER + CLIENT ACCOUNTING SERVICES MANAGER
Amanda Harpster is a Client Accounting Services Manager at Lutz with over 14 years of relevant experience. She focuses on QuickBooks support, tax and payroll compliance, and small business consulting.
AREAS OF FOCUS
AFFILIATIONS AND CREDENTIALS
- Intuit Certified ProAdvisor, QuickBooks
- BSBA in Accounting, University of Nebraska, Omaha, NE
- St. Patrick’s Parish, Volunteer
- Cub Scout Pack #409, Treasurer
- Ponca Hills Fire Department Women’s Auxiliary, Member
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