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Time for a little Business 101. If you’re confident you already understand major business entities and which will be most advantageous to you and your investors, read this anyway. And then, read it again. There are numerous considerations you might make, and it never hurts to revisit them. Choosing your business entity isn’t a permanent decision, but without enough information to frame intelligent questions, you may kick yourself when tax season comes around. Or worse. Myopic business planning could jeopardize health and retirement plans, and both your family and employees needs.
Let’s start with the basics. If you’re looking in encourage venture capitalist oversight, you must start with a corporation (C-corp or S-corp) or a limited liability corporation (LLC). Again, you can modify your entity down the road, but there are some limitations. The S-Corporation, for example, may only change every five years. If you’re more self-reliant than all that, you may choose to start a sole proprietorship, a smaller LLC or limited partnership with, say, a spouse or someone you know. Using this model doesn’t mean you can’t have investors; it just means you have the ability to keep them at arm’s length.
We can generally put business entities operating in the U.S. in two camps: the ones that pay the taxes, and the ones that pass them on to you. Sole proprietorships, Limited/General/Limited liability partnerships and S-Corps are of the latter and are called “pass through” entities. These require you to pay at your highest tax bracket and submit a separate annual information return. A corporation, alternatively, pays taxes, but you must also pay taxes on wages or dividends paid to you. Usually, unless you’re already in the highest personal tax bracket, you should stay away from the corporate model for this reason. The LLC is a exception in that you have the choice of reporting either way.
Keep in mind that self-employment taxes will cost 15.3% of your business profits, and income for the latter–excluding the S-Corp–are subject to self-employment taxes. Another bit to think about: payroll. S-Corps, LLCs and corporations must pay their working officers a reasonable salary as determined by the IRS. This does not extend to all other entities, where wages are not permitted for owners.
Before we go into a few general remarks on business entities and the corresponding tax documentation required, remember that there are by-laws and exceptions from state to state. For example, the state of California charges minimum taxes for LPs and general revenue taxes for LLC’s which makes them a much less attractive choice for business owners in that state. Be sure to check with your state’s requirements and federal tax regulations to stay ahead of the curve.
A sole proprietorship means flying solo. It’s cheap to set-up and you have total control over business decisions. If you’re in business with anyone else, including your spouse the IRS frowns upon reporting income this way. A business tax return will be filed with your personal return by using the long 1040 and Schedule C form.
Listed below are the corresponding tax forms required:
For Income Tax, use these forms:
For Self-Employment Tax, use these forms:
For Social Security, Medicare Taxes, and Income Tax Withholding, use these forms:
To Provide Information on Social Security, Medicare Taxes and Income Tax Withholding, use these forms:
For Federal Unemployment (FUTA) Tax, use these forms:
A partnership, be it a general partnership (GP) or limited partnership (LP) is created when at least two people go into business together. The limited partnership has an added bonus in that it allows partners to put money into the entity while remaining protected from a business lawsuit or liability. Limited partners, though, don’t get to make decisions, and there must be one general partner who takes on total liability. Income is reported on Form 1065, with Schedule K-1s issued to partners.
Limited liability partnerships (LLP), like its namesake infers, also provides liability protection for limited partners. It is an entity allowed by state statute and is usually reserved for professional folks with special licenses, like lawyers, accountants and architects and also avoids the double taxation present in corporations.
Listed below are all tax forms required:
Employment taxes – which include social security, Medicare taxes, income tax withholding, federal unemployment (FUTA) tax, and depositing employment taxes, use these forms:
If you are a PARTNER (individual) in a partnership, use these forms:
For Income Tax, use:
For Self-Employment Tax, use:
For Estimated Tax, use:
Finally, we’ll speak briefly on corporations of which there are two types: S-Corps and C-Corps. Again, because we’re dealing with small business here, we’re generally staying away from these publicly traded companies. But if you’re making enough to afford expenses to set up and–in the case of a C-Corp–afford double taxation, the advantages of liability protection, class structure, and a preferred tax rate, might be your best bet. S-Corps have all the same protections of C-Corps as listed above, but also the advantages of partnerships while circumventing the double taxation. If you do choose an S-Corp, be sure to file the election, or have the tax pros at BlueTax do it for you as paralegals often overlook this.
Listed below are the corresponding tax forms required for S-Corps and C-Corps:
If you are an S corporation, follow the instructions below for the proper forms to use.
For Income Tax in an S corporation, use these forms:
For Estimated Tax in an S corporation, use these forms:
For Employment Taxes in an S corporation – which include social security, Medicare taxes, income tax withholding, federal unemployment (FUTA) tax, and depositing employment taxes, use these forms:
If you are a shareholder in an S corporation, follow the instructions below for the proper forms to use.
For Income Tax, use these forms:
For Estimated Tax, use these forms:
For Income Tax in a C corporation, use these forms:
For Estimated Tax in a C corporation, use these forms:
For Employment Taxes in a C corporation – which include social security, Medicare taxes, income tax withholding, and federal unemployment, use these forms:
From here, you can decide if you’ll need to file an SS-4 Form online to create your Employer Identification Number (EIN). Unless you are running a business without employees, are operating outside of a corporation or partnership and are not involved with a trust, estate, mortgage investment conduit, farmer’s co-op or plan administrators, you will be required to create an EIN. If your business structure or ownership changes, your EIN will too. Otherwise, regardless of business name or location changes, it will remain the same.
So, what best suits your business body? Still not sure? Don’t get overwhelmed by the details. What’s presented above is a basic overview of your options, not a death sentence. Just go through the pros and cons like a checklist and knock off those that don’t apply to you. Then, consider consulting with an attorney. Choosing your business entity is an important decision, but don’t labor over it endlessly. From here, the joy of running a business can begin.