Choosing the correct business entity is important because each entity type has different legal protection and have different tax advantages. There are a few different types of business structures. There are Sole Proprietorships, LLCs, Partnerships, S-Corps, and C-Corp that you can choose to make your business.
Sole Proprietorships provide no additional legal protection from the business and your personal life because sole proprietorships are not a separate legal entity. They are seen as an extension of the individual and are taxed at the individual level on schedule c of form 1040. The individual will have to pay self-employment tax on the profits of the business.
Partnerships require at least two different partners to form, these partners can be businesses or individuals. In a partnership, there is additional legal protection for a partner’s personal assets which can become beneficial in the case of a lawsuit. Partnerships are taxed through form 1065, which could require additional tax preparation fees, but can add tax savings to the partnerships depending on how the income is structured to flow through to them on the individual level.
S-corporations are corporations that can have a single owner and provides that owner with additional legal protection than a sole proprietorship. S-corps file their taxes on form 1120-S and pay no tax at the business level (different than the C-corp) and passes on the income to the owner(s). One of the biggest tax advantages of the S-corp I that the owners do not pay self-employment tax on their portion of the business income, even if they actively participate in the business.
LLCs (Limited Liability Company) is a hybrid between the partnership and the S-corp. There can be single-member LLCs or LLCs with multiple owners. There is additional legal protection offered, and there is more flexibility in the tax structure. Single-member LLCs that are considered a disregarded entity are taxed on the individual’s schedule c on form 1040. Multi-member LLCs have the option of being taxed as either a partnership or an S-corp.
C-corporations are what the fortune 500 companies are. C-corps offer additional legal protection and can offer different routes to help raise funding for your company. There are some negative tax consequences for small businesses that chose this route. C-corps are taxed at the business level when it files form 1120. If the company passes on that income to its owners, that same income (which has already been taxed at the company level) is then taxed at the individual level as dividends on schedule B of form 1040.
If you are still wondering which business entity is right for you and would like to find out all of the benefits of a certain business structure please feel free to contact Ferretti CPA for a consultation.