I get asked this question a lot in terms of what a person should do for the best tax break and the answer is that it depends on your business.
A business entity is the legal and tax form of business separate from the taxpayer or taxpayers involved. For example, Amazon, Inc. is a business entity made up of thousands of shareholders and employees. Amazon, or Google or British Petroleum, the business entities, could continue to exist for the next several hundred years. Just like an individual, the companies may own and operate more than one business. Ownership may change hands. The business may take on debt and pay taxes. Millions of small business owners dream that their business will someday grow into such a business that will live on past their own lifetime. However, in order to do this, the business will have to separate itself from the taxpayer and become its own “living” entity.
The IRS recognizes only four types of business entities:
• Sole proprietorships
• Partnerships
• C corporations
• S corporations
Limited liability companies are another business entity, but they are an entity for legal purposes. As you will learn, limited liability companies (LLCs) can be sole proprietorships, partnerships, or corporations for tax purposes.
The Sole Proprietorship
You are already familiar with a sole proprietorship. A sole proprietor is an individual operating a business as a self-employed person. The owner is liable for all business debts and actions and receives all the profits and losses from the business. The sole proprietor’s income is reported on Form 1040, Schedule C; the maximum tax rate on this income is 35% for 2008. If the proprietor’s net self-employment income is $400 or more, he or she also pays self-employment tax.
What is a Partnership?
Not every business consists of just a single taxpayer. A partnership is an association of two or more persons to carry on a business for profit as co-owners. This relationship can be formed whether or not the partners intend to form a partnership. Merely sharing expenses does not necessarily constitute a partnership. Each person may contribute money, property, labor, or skill to the partnership. The business can be in any trade, occupation, or profession and includes financial operations
or ventures. Individuals, estates, trusts, corporations, or other partnerships may be partners in a partnership. For the purpose of this course, all partners discussed are assumed to be individuals. A partnership can be a general or a limited partnership. Joint ventures, pools, syndicates, or other unincorporated organizations that carry on business are also classified as partnerships. Limited liability companies (LLCs) may be classified as partnerships for federal tax purposes (this will be discussed later in this chapter).
What is a Corporation?
Amazon, Google, Marvel Comics, Disney are examples of corporations. In general, a corporation is an entity that has been formed under a federal or state law that refers to the business as a corporation, body corporate, or body politic.
Other organizations taxed as corporations include associations, jointstock companies, insurance companies, certain banks, and government-owned businesses. Other entities that are not corporations by definition can elect to be taxed as corporations. For legal purposes, a corporation is formed by requesting and receiving a corporate charter from the appropriate state authority (often the Secretary of State).
The corporation can then issue capital stock in exchange for money or property (capital) that its prospective owners (shareholders) contribute. Each shareholder receives a stock certificate that shows how many shares he or she owns, and the corporation receives the capital it needs to begin business operations.
What is an S Corporation?
In the legal sense, an S corporation is no different from any other corporation. It is incorporated under the laws of a particular state and has the attributes and legal benefits of a corporation. The election to be an S corporation is merely a tax decision.
What is a Limited Liability Company?
Limited liability companies (LLC) are created and governed by state laws. Most states allow one-owner LLCs. One-owner LLCs can file their federal tax returns as sole proprietors, or if authorized by the state, as C corporations or as S corporations. LLCs with more than one owner can file their federal tax returns as partnerships, or if authorized by the state, as C corporations, or as S corporations
.
Owners of LLCs are called members.
A good rule of thumb is to go with the easiest business entity that you can to get started with a business. It is always easier to go up than go down.
Oct 09 2009
Kim Isaac Greenblatt
What Is A Business Entity