When starting a new business, choosing your legal structure is one of the most important decisions you’ll have to make. The structure you choose will influence many areas of your business including your tax filing, your personal liability and your ability to receive funding. As a business owner, you can structure your business as a sole proprietorship, a partnership, an LLC, a S-Corporation, or a C-Corporation.
The sole proprietorship is the most basic type of business entity. Under this structure, all the assets and liabilities belong to the business owner. Because of this, your business income is your income, and you report it on the Schedule C of your Form 1040.
If you are in a business with one or more partners, you could consider a partnership. Unlike a sole proprietorship, a partnership needs to register with the IRS, state, and local tax revenue agencies. The partnership itself does not pay income tax because the profits pass through to its owners. A partnership provides a Schedule K-1 to each of the partners, who then file it with their Form 1040.
If you’re looking to have your business taxed separately, you can establish a S Corporation (S Corp). Since the S Corp is taxed as its own entity, a business owner can obtain tax savings because they are taxed only on their wages. An S Corp reports income on Form 1120S.
Structuring your business as a C Corporation (C Corp) is less popular among small businesses because it is more complicated and costly due to administrative fees. Additionally, it has a major drawback, referred to as “double taxation.” The C Corp is taxed and then its shareholders are taxed again upon distribution of dividends. This structure is usually more popular for small start-up companies because C Corps can offer stock in exchange for an ownership stake. A C Corp files a Form 1120.
A Limited Liability Corporation (LLC) combines the tax pass-through of a partnership and the limitation of liabilities like a corporation. LLCs have the most flexibility when it comes to filing taxes. They can be taxed like a sole proprietor (for one member), partnership (for two or more members), or a corporation (C or S).
The legal structure you choose will have a continuous impact throughout the life of your business. Consulting with a legal and financial expert can help you make the best decision for your situation.