Having a good idea for a small business is only the beginning. From tax considerations to legal liabilities and ownership share, structuring your business is a vital part of any startup.
Sole proprietorships are the default classification of an individually owned business for legal and tax purposes. The sole proprietorship is not considered a separate legal entity, meaning the business will not pay separate income tax. However, a sole proprietorship offers no legal barrier between your assets and the business; liabilities for the business flow through to you as well, which creates a risk for the individual.
A partnership requires two or more owners, which can be either individuals or business entities. Each person contributes to the running of the business and will share in profits and losses. If two people are in business together and share profits proportionally, the law assumes a general partnership.
A partnership does not pay income tax. Instead, like a sole proprietorship, profits, losses and liabilities “pass through” to its partners. Furthermore, partners can be liable for the actions of other general partners, creating a good deal of risk for each partner.
If you choose to operate as a partnership, you may wish to consider a limited partnership. You must file with your state to be a limited partnership. This form of business ownership includes a general partner and a limited partner or partners. The limited partners are treated the same as general partners for tax purposes, but are not liable for the liabilities of the partnership in the same way as a general partner.
Limited Liability Company (LLC)
The LLC is a great tool for individuals and small businesses to obtain “pass through” tax treatment from the IRS, while protecting the individual(s) from liabilities arising from the business. However, some states, including Pennsylvania, do impose a capital tax on LLCs.
Corporations are considered a separate legal entity from its shareholders and so must pay federal taxes on its income. Shareholders must also report and pay taxes on individual income gained, called a “double tax.” A C corporation is generally used only for entities that do not qualify as an S corporation.
S corporations pass income and losses to shareholders, who report it on their personal tax returns. A corporation must file a form with the IRS to “elect” to be taxed as an S corporation. However, the corporation will be classified as such only if it meets certain qualifications regarding the number of shareholders and entity type.
Consult An Attorney
This basic information is not enough to fully decide what the best business entity is for you. Consult with corporate law and business planning attorneys in your area for more information on what business structure is right for you.