Both new and existing business owners need to understand the different business structures to find the most advantageous option for financial and tax reporting purposes. There are five common types of business structures that exist in the US. They include sole proprietorships, limited liability companies, partnerships, S-corporations and C-corporations, each with different maintenance and taxation requirements.
The simplest and most cost-effective business setup is a sole proprietorship. This structure is designed for a single individual owning the business with all income and loss being reported on the individual return. Many small business owners lean toward this structure for new operations; however, there are limits on capital raising activities. No additional partners can be brought on, requiring you to fund your business through your contributions alone.
Limited Liability Company
The next structure available for businesses is a limited liability company. Single-member limited liability companies are treated as a sole proprietorship for tax reporting purposes. Nevertheless, multi-member limited liability companies will be required to file a separate business return. Owners of a limited liability company are referred to as members and receive added flexibility when it comes to distributing profit. The setup procedures for a limited liability company are greater in scope, requiring member agreements and annual fees.
A partnership is a business structure that has more than one owner. Each owner is referred to as a partner and will have a specified ownership percentage according to an agreement. General partnerships must include at least one general partner that is liable for liabilities in the event of a default. On the contrary, a limited liability partnership provides liability protection for all partners. Partnerships provide more opportunities to raise capital through partner contributions; however, there are also expanded financial and tax reporting regulations. A separate partnership return is required to be filed each year with any income or loss being passed through to the individual return.
S-corporations have gained popularity in the past few years for both growing and new businesses. S-corporations combine features of a partnership and c-corporation, passing through income to the individual level but providing added ease when looking to sell your shares. Moreover, s-corporations have the ability to implement tax planning strategies, such as paying state taxes at the corporate level, paying owners a distribution and salary and taking federal and state tax credits. However, s-corporations can be costly to maintain with added financial and tax reporting obligations.
Large enterprises tend to lean towards c-corporation status because of access to capital raising activities and favorable tax breaks. Unlike the previous business structures, c-corporations pay all taxes at the corporate level, which can result in favorable tax deductions depending on current tax rates. Moreover, c-corporations are able to issue stock through initial public offerings, giving the business access to capital quicker. Despite these advantages, many business owners don’t see personal tax benefits from credits and deductions, such as the Qualified Business Income Deduction, because everything is reported at the corporate level.
Choosing the right business structure for your needs takes careful consideration of tax and financial advantages and disadvantages. Working through these requirements alone can become burdensome, which is why many business owners and entrepreneurs reach out to their tax advisors, and financial planners.
Please consult legal, tax, accounting or other professional advisors before implementing any structures that are presented in this resource.