Choosing a Business Structure

How your company should be structured is one of the first decisions you will have to make as a business owner? This decision is important, because the type of business you create determines the types of applications you’ll need to submit. You should also research liability implications for personal investments you make into your business, as well as the taxes you will need to pay.

It’s important to understand each business type and select the one that is best suited for your situation and objectives. Keep in mind that you may need to contact several federal agencies, as well as your state business entity registration office. In making a choice, you will want to take into account the following:

• Your vision regarding the size and nature of your business.

• The level of control you wish to have.

• The level of structure you are willing to deal with.

• The business' vulnerability to lawsuits.

• Tax implications of the different ownership structures.

• Expected profit (or loss) of the business.

• Whether or not you need to reinvest earnings into the business.

• Your need for access to cash out of the business for yourself.

Your type of business determines which income tax form(s) you have to file. Common business structures are sole proprietorship, partnership, corporation, S corporation, and limited liability company (LLC). Legal and tax considerations enter into selecting a business structure.

Sole proprietor

An individual who owns an unincorporated business by himself/herself.

Advantages of a Sole Proprietorship

• Easiest and least expensive form of ownership to organize.

• Profits from the business flow directly to the owner's personal tax return.

Disadvantages of a Sole Proprietorship

• Sole proprietors have unlimited liability and are legally responsible for all debts against the business. Their business and personal assets are at risk.

• May be at a disadvantage in raising funds and are often limited to using funds from personal savings or consumer loans.

Federal Tax Forms for Sole Proprietorship
(only a partial list and some may not apply)

• Form 1040: Individual Income Tax Return

• Schedule C: Profit or Loss from Business (or Schedule C-EZ)

• Schedule SE: Self-Employment Tax

• Form 1040-ES: Estimated Tax for Individuals

• Form 4562: Depreciation and Amortization

• Form 8829: Expenses for Business Use of your Home

• Employment Tax Forms

Partnership

A relationship where two or more persons join together to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.

Advantages of a Partnership

• Partnerships are relatively easy to establish; however time should be invested in developing the partnership agreement.

• The business usually will benefit from partners who have complementary skills.

Disadvantages of a Partnership

• Partners are jointly and individually liable for the actions of the other partners. Since decisions are shared, disagreements can occur.

• Profits must be shared with others.

Federal Tax Forms for Partnerships
(only a partial list and some may not apply)

• Form 1065: Partnership Return of Income

• Form 1065 K-1: Partner's Share of Income, Credit, Deductions

• Form 4562: Depreciation

• Form 1040: Individual Income Tax Return

• Schedule E: Supplemental Income and Loss

• Schedule SE: Self-Employment Tax

• Form 1040-ES: Estimated Tax for Individuals

• Employment Tax Forms

Corporation

A relationship where prospective shareholders exchange money, property, or both, for the corporation’s capital stock. Profits are taxed to the corporation when earned and then taxed to the shareholders when distributed as dividends.

Advantages of a Corporation

• Shareholders have limited liability for the corporation's debts or judgments against the corporations.

• Corporations can raise additional funds through the sale of stock.

Disadvantages of a Corporation

• The process of incorporation requires more time and money than other forms of organization.

• Corporations are monitored by federal, state and some local agencies, and as a result may have more paperwork to comply with regulations.

Federal Tax Forms for Regular or "C" Corporations
(only a partial list and some may not apply)

• Form 1120 or 1120-A: Corporation Income Tax Return

• Form 1120-W Estimated Tax for Corporation

• Form 8109-B Deposit Coupon

• Form 4625 Depreciation

• Employment Tax Forms

• Other forms as needed for capital gains, sale of assets, alternative minimum tax, etc.

S corporation

A corporation, meeting certain criteria, that elects to be treated as an S corporation. Generally an S corporation is exempt from income tax; the shareholders report the S corporation’s income, deductions, loss and credits on their individual tax returns.

Federal Tax Forms for Subchapter S Corporations
(only a partial list and some may not apply) Form 1120S: Income Tax Return for S Corporation

• 1120S K-1: Shareholder's Share of Income, Credit, Deductions

• Form 4625 Depreciation

• Employment Tax Forms

• Form 1040: Individual Income Tax Return

• Schedule E: Supplemental Income and Loss

• Schedule SE: Self-Employment Tax

• Form 1040-ES: Estimated Tax for Individuals

• Other forms as needed for capital gains, sale of assets, alternative minimum tax, etc.

Limited Liability Corporation (LLC)

An entity—statutorily authorized in certain states—that is characterized by limited liability for debts similar to that of a corporation, management by members or managers, and pass-through taxation similar to that of a partnership.

Federal Tax Forms for LLC

• Taxed as partnership in most cases; corporation forms must be used if there are more than 2 of the 4 corporate characteristics, as described above.

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Researching business structures:

Go to a library or a large bookstore: Find the small business section where there are various books on how to form an LLC or corporation. A few hours pouring over them will probably give an entrepreneur a basic understanding of the different structures and how to establish them. Many of the books come with a CD offering step by step instructions.

Visit your state's Web site: Every state has a Web site. For example, the Texas and Virginia sites feature a business section where you can find information on how to start a business in that state. They also offer frequently asked questions and toll-free numbers to aid with questions on sales taxes and other information.

Meet with an accountant, business consultant or tax adviser:: Spend a few hundred dollars working with them to help determine which legal entity will be the most financially advantageous for you.

Determine whether you're going to file the paperwork yourself: Once you decide upon a legal structure, you need to determine whether you're going to file for it yourself. In most circumstances, you probably don't need an attorney. But if you have done your preliminary research and you remain confused, there's nothing wrong with hiring a professional or using an online service to incorporate you.

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