Starting your business in the USA is a legal matter that contains various questions that need clarification. Depending on the size of your business (starter or established) and your personal preferences regarding tax returns (pass-through or double taxation) or how you want your company to be managed dictates manifold ways of structuring your economic venture. Here in this introductory writing, you will be reading the 5 most common business structures as stated on Internal Revenue Service’s (IRS) website, and hopefully have an idea as to how you might want to move on with your business formations in the future.
As the name suggests, Sole Proprietorships or DBA’s (Doing Business As) refers to a business structure in which you are the sole owner of your company. This means that your company is you, which makes you the only person liable for the business entity at hand. Furthermore, you are being personally liable for your company subjects you to pass-through taxation with which your business income or loss is added to your tax returns. And this merger of person and corporation appoints you as the guarantee for potential company debt that consequentially may jeopardize your possessions and savings in a likely lawsuit.
Partnership/ General Partnership:
Partnership business structure is almost identical to Sole Proprietorship with one, but major difference. With this corporate type, multiple owners invest in the business either through money, property, labor, or skill. People taking part in a certain partnership have distributed the profits and losses of the company in accordance with their shares of the business.
Moreover, Partnerships are bound to file an annual report detailing their income, gains, deductions, losses, etc., resulting from their operations. However, this does not require partnerships to pay income taxes as business entities. Like Sole Proprietorship, they are subjected to pass-through taxation that mandates not the company, but shareholders to report their income-gained or loss-given (calculated accordingly to their shares on the partnership) on separate, individual tax returns.
As the oldest business structure in the US, C or Regular Corporation – unlike Sole Proprietorships- is defined as a separate company entity that shields shareholders from the personal liability of business operations. This protection is since C Corporations are not to be owned as business organizations, but as ‘stocks’ that are bought and sold in-between numerous investors.
The distinction between companies and shareholders, on the other hand, results in a double tax that obliges C Corporations and their shareholders to be taxed separately. Firstly, profits gained from business operations are taxed to corporate, followed by the taxation of shareholders through distributed dividends, derived from the profit. However, additional tax cost dictated to C Corporations is avoidable via another business structure, called S Corporation, that spurs many investors to change their company types from C to S.
Preferable for most starter small companies, S corporation, like Sole Proprietorship and Partnership, allows businesses to pass through the profit directly to shareholders. This enables corporations to avoid double taxation, thus reducing the additional cost of company income tax. However, the formation of S Corporations is comparatively tight regulated as it outlines various rules such as,
- Your corporation must be a domestic one.
- Partnerships, corporations, and non-resident shareholders are not allowed.
- You cannot have more than 100 shareholders.
- Stocks owned by shareholders can only be one type.
- Financial organizations, i.e., banks, insurance companies, and domestic international sales corporations are considered ineligible.
Limited Liability Corporation (LLC):
As being the newest amongst the 5 most common business structures, LLC offers flexibility and more space for businesses to operate. Bringing together the personal liability exception of a company (C or S) with pass-through taxation, LLC protects you from indulging in potential business debts as well as spending the added cost of double tax.
Furthermore, there are far fewer restrictions about ownership, allowing single or multiple members (LLC owners are called members, not sole owners, or shareholders) ranging from corporations to other LLCs, and foreign nationals to institutions to own businesses. Several exceptions for ownership include business types such as banks and insurance companies.
Lastly, IRS will categorize your LLC as a corporation, partnership, or as a disregarded entity (meaning an entity that is not separated from its owner, i.e., Sole Proprietorships) depending on the number of your members and on elections made by the LLC, providing you with the opportunity of multiple business structures as you complete the way your tax returns are declared.
For further, state-specific regulations on business structures and taxation, follow this; link. And please regularly visit our blog for more comprehensive writings on business structures of which the next will be on LLCs.