As I noted in an earlier issue, one of the most important decisions a new business owner ( also an existing owner) can make is the choice of the business entity. An informed choice not only affects tax issues, but affects legal, regulatory, and professional aspects as well.
Basically there are four types of business entities, a Sole Proprietorship, a Partnership, a Corporation, and a Limited Liability Company or LLC.
A Sole Proprietorship consists of one individual that carries on a trade or business. It requires no formal organization, thus the easiest entity to form and to dissolve. The only bookkeeping requirement is that the system must clearly reflect income and expenses and it must be consistent. Intermingling of personal and business funds is permitted, although definitely not recommended. The net profit or loss is computed on Schedule C and reported on the owners tax return (Form 1040.)
A Partnership is an organization having two or more owners that function as a trade or business. It is relatively easy to organize, with no written agreement required but a written partnership agreement is recommended. Partnership income and losses flow to the partners tax return and are allocated by ownership interest if no agreement exists. Also losses can be limited. By agreement and depending on income and assets, the partnership may be required to include a balance sheet, thus double-entry bookkeeping may be required. It files Form 1065.
Partnerships combine the skills and abilities of several people who hopefully complement each other.
A Corporation is a business entity that carries its own legal A status that is separate and distinct from its owners. It is usually organized by a state. A corporation must comply with state and federal regulations. Generally a corporation pays its own taxes on its income. Profits can also be distributed to the shareholders in the form of dividends and are taxed to the shareholder. A corporation can if it meets certain requirements elect to be a “Sub S-Corp.” This means that instead of the profits being taxed at the corporate level, the profits “flow-through” to the individual shareholder and is taxed on the individuals tax return (very similar to the a partnership.) The S-Corp is very popular for small, closely held corporations primarily because it avoids the “double taxation” that can occur with a regular corporation.
The Limited Liability Company or LLC is an entity formed under state law. Most importantly for tax purposes it is known as a “disregard-entity,” that is the LLC status is disregarded. Thus a single member LLC is by default taxed as a Sole Proprietorship. If it is a multiple member LLC, it is taxed as a partnership. Furthermore, an LLC can by meeting certain requirements still be a corporation or even a Sub S corporation. In conclusion, I’d like to point out that as your business changes you can also change your business entity. But it should be done carefully and thoughtfully.
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An enrolled agent, licensed by the US Department of the Treasury to represent taxpayers before the IRS for audits, collections and appeals. To attain the enrolled agent designation, candidates must demonstrate expertise in taxation, fulfill continuing education credits and adhere to a stringent code of ethics.