Many new business owners, those thinking of starting a new business as well as those who already have an existing business always ask what type of business entity is best for them. There is no clear cut answer, but the business entity you select should be based upon three criteria; liability, taxation and recordkeeping.
The types of entities to select from are; Sole proprietorship, Partnership, Corporation, S-Corporation and Limited Liability Company (LLC). We can break these down quickly based upon the three criteria mentioned earlier.
Sole Proprietor: The easiest form of ownership to set up. It offers complete control of the business to one owner. No federal id# is required unless there are employees, excise or sales taxes. The owner is self employed and may find it necessary to file personal estimated tax four times a year to cover any profit from the business. The income or loss is combined with all other income on the owner’s personal tax return. The owner is personally liable for all debts and obligations and all personal and business assets may be subject to liability. Recordkeeping is fairly simple.
Partnership: Consists of two or more individuals. Taxes flow through to each partner based upon their percentage of ownership. The partnership files form 1065 each year and each partner is responsible for filing estimated taxes to cover any profit passed through to them. Recordkeeping will also include keeping track of each partner’s capital account consisting of withdrawals, contributions, income and loss.
Corporation: A corporation is taxed separately on any profits from the business. Shareholders (owners) are taxed as employees and receive W-2 wages. These wages are a deduction to the corporation unlike sole proprietors and partnerships which are called 'draws' when proceeds are distributed to their owners, which are NOT deductions to those types of entities. The corporation files form 1120 or 1120-A each year. The shareholders have limited liability under this type of entity. Recordkeeping is more complex than a sole proprietorship but less than a partnership.
S-Corporation: This entity is similar to a regular corporation except the shareholders elect by filing form 2553 to have profits and losses passed through to shareholders typical to a partnership. As with corporations, the shareholders are employees and receive W-2 income deductible by the S Corp. Shareholders have limited liability here as well. Recordkeeping is slightly more difficult than a regular corporation.
Limited Liability Company: This is similar to a partnership but it includes limited liability for the partners (called 'members'). Income or loss passes through to the members and members are responsible for paying taxes on their personal returns and may have to file estimated tax payments. Recordkeeping is similar to regular partnerships.
Most new business owners chose either the S-Corp or Limited Liability Company (LLC). I have found that those owners that have little experience running a business or preparing payroll and payroll tax filings are better off using the Limited Liability Company entity since it provides limited liability protection to the members and removes the cumbersome payroll tax filings necessary if there are no employees.
Always be sure to ask your personal tax preparer to discuss your selection so that it is tailored to your personal tax situation and state requirements.
William Farrell CPA PC is a CPA firm located in North Carolina providing tax, accounting, bookkeeping, Quickbooks setup and financial planning throughout the United States in personal and via remote access. Please contact me via e mail at wpfarrell@nc.rr.com or visit my website www.wfarrell.com You can also follow me on twitter at FarrellCPA.
