Business Structures Defined
How your business structure impacts the tax preparation process.
The business structure you select defines the legal and operational framework within which your business operates—and has significant implications for your financial management, liability, and taxation.
Here is an overview of common business structures, the critical differences among them, and how the tax preparation process can differ depending on which type is selected:
Sole Proprietorship
Ownership: Owned and operated by a single individual.
Liability: The owner has unlimited personal liability for business debts and obligations.
Taxation: Business income is reported on the owner’s personal tax return, and they are responsible for paying income taxes on the business’s profits.
Tax Form: Sole proprietors report business income and expenses on their personal tax return using Schedule C (Profit or Loss from the business).
Tax Deductions: Owners can deduct business expenses from their income, potentially reducing taxable income.
Fees: In many places, a sole proprietorship may have little to no formal registration fee, as the business is often tied to the individual owner.
Partnership
Ownership: Owned by two or more individuals sharing responsibilities and profits.
Liability: Partners may have unlimited personal liability, depending on the type of partnership (general or limited).
Taxation: The business itself does not pay taxes. Instead, profits and losses flow through to the partners, who report them on their individual tax returns.
Tax Form: Partnerships file an informational tax return (Form 1065) to report income, deductions, and credits. However, the partnership itself does not pay income taxes.
Tax Deductions: Partners can deduct their share of partnership losses and business expenses on their individual returns.
Fees: Legal fees may be incurred when creating the partnership agreement, which outlines the rights and responsibilities of each partner.
Limited Liability Company (LLC)
Ownership: Combines elements of both partnerships and corporations, providing flexibility in ownership structure.
Liability: Owners (members) have limited personal liability, protecting personal assets from business debts.
Taxation: Members can choose to be taxed as a partnership (pass-through taxation) or as a corporation if eligible. Tax liability varies based on the selected tax classification. In most cases, LLC members report income and deductions on their personal tax returns.
Tax Form: LLCs can choose how they want to be taxed: as a disregarded entity (like a sole proprietorship), a partnership, an S corporation, or a C corporation.
Tax Deductions: Members can typically deduct their share of business expenses and losses.
Fees: Aside from the legal fees incurred from creating the operating agreement, there are fees associated with filing the Articles of Organization with the state to establish the LLC and to file the annual or periodic reports, which many states require.
C Corporation (Corporation)
Ownership: Owned by shareholders, managed by a board of directors and run by officers.
Liability: Shareholders have limited liability, and their personal assets are generally protected from business debts.
Taxation: Corporations are subject to corporate income tax, and shareholders may face double taxation (taxes on corporate profits and taxes on dividends).
Tax Form: C Corporations file their own tax return (Form 1120) and pay corporate income tax on profits. Shareholders report dividends on their individual tax returns.
Tax Deductions: The corporation can deduct business expenses, potentially lowering its taxable income.
Fees: There are fees for filing the Articles of Incorporation with the state to establish the corporation and to file its annual reports, which many states require. In addition, the business structure is more likely to have ongoing legal and compliance costs associated with maintaining corporate status and potentially higher tax preparation fees due to the complexity of corporate taxation.
S Corporation (S Corp)
Ownership: Similar to a regular corporation but with restrictions on the number and type of shareholders.
Liability: Shareholders have limited liability.
Taxation: Like an LLC, an S Corporation has pass-through taxation, with profits and losses flowing through to shareholders, who report them on their individual tax returns.
Tax Form: S Corporations file Form 1120S, an informational return. Like partnerships, S Corporations don’t pay income tax; profits and losses pass through to shareholders.
Tax Deductions: Shareholders can deduct their share of business expenses.
Fees: Similar to C corporations, fees are associated with filing the Articles of Incorporation, filing the required annual reports with the state, and ongoing legal and compliance costs.
The Bottom Line
Selecting the proper business structure depends on various factors, including the nature of the business, the number of owners, liability considerations, and tax implications. It’s advisable to consult with legal and financial professionals when making such decisions to ensure alignment with your business goals and compliance with applicable laws.
