August 4, 2014
John Owner Business Structure Options
Dear Mr. Owner, Having a strong business plan is a good start to starting your business. The various structures, advantages, disadvantages, and tax liabilities are important to know before you make that decision. The opportunities are a sole proprietorship, partnership, corporation, S corporation, and limited liability company (LLC). Sole proprietorship is the more common structure owned and operated by one person. Advantages to a sole proprietorship are minimum legal limitations, easy construction, low start-up costs, sole proprietorship of profits and maximum freedom in decision-making (The U.S. Small Business Administration, 2014). Disadvantages for a sole proprietorship are unlimited liability, less available capital, and relative difficulty in obtaining long-term financing (The U.S. Small Business Administration, 2014). Sole proprietor is considered a “pass-through” tax entity. All incomes and expenses are passed to the owner. The owner has to report income and/or losses and expenses using a schedule C on a standard 1040 tax form (Gaff & Fryzel, 2012). Partnership is similar to the sole proprietorship except that two or more people jointly own the company. Advantages of a partnership is the ease of formation, direct rewards, and broader management base due to a greater number of owners (The U.S. Small Business Administration, 2014). Partnership disadvantages are unlimited liability of general partners, divided authority, and difficulty disposing of limited partnership interest (The U.S. Small Business Administration, 2014). Partnership taxes include Annual Return of Income, Employment Taxes, and Excise Taxes. Partnership partners are liable for added taxes, including Income Tax, Self-Employment Tax, and Estimated Tax (Callaway, Wolf, & Kramer, 2002). The company pays no income tax. However, it must complete and file a partnership informational return, Form 1065 (Gaff & Fryzel, 2012). Partnership is also a “pass-through” entity passing profits and losses to partners on their personal income tax returns.
Corporation is when a company is viewed as a separate entity from the proprietors. Advantages of a corporation are separate legal entity, limited liability for stockholders, unlimited life of a business, relative ease in raising capital, transfer of ownership through sale of stock, and can use different classes of stock (The U.S. Small Business Administration, 2014). Corporation disadvantages consist of organizational complexity, expense activities limited by agreement, extensive regulation record-keeping requirements, and double taxation of revenues and dividends (The U.S. Small Business Administration, 2014). Corporation proprietors pay taxes on their revenues while being taxed double; once on the revenues and then again on dividends paid to stockholders on their personal returns. Tax forms that need to be filed are 1120 or 1120 A (Gaff & Fryzel, 2012). An S corporation has to be filed first as a corporation. Once a company is considered as a corporation, all shareholders must sign and file a Form 2553. The form elects the corporation to become an S Corporation. S corporation advantages include limited liability for shareholders, and unlimited life of the corporation (The U.S. Small Business Administration, 2014). Disadvantages of an S corporation are restrictions on the number and type of shareholders, and limitations on classes of stock that may be released (The U.S. Small Business Administration, 2014). Something to keep in mind is that not all states treat S corporations equally. Majority of the states treat them similar to the federal government by taxing the stockholders applicably. Depending on your state, your S corporation could be taxed on profits above a certain limit, taxed like C corporation or taxed on both the S corporation and shareholder’s profits. The tax Form 2553