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Basic Business Forms
Every business, from a part-time operation you run from home while in your jammies to a Fortune 500 multinational company housed in a gleaming skyscraper, has a legal structure. If you're running a business right now, it has a legal form even if you made no conscious decision about how it should be legally organized.
The four basic legal structures for a business are sole proprietorship, partnership, limited liability corporation, and corporation. For tax purposes, corporations are either S corporations (corporations that have elected pass-through tax treatment) or C corporations (also called regular
corporations). Every business falls into one of these categories -- and your category will determine how your business's profits will be taxed.
A sole proprietorship is a one-owner business. You can't be a sole proprietor if two or more people own the business (unless you own the business with your spouse). Unlike the other business forms, a sole proprietorship has no legal existence separate from the business owner. It cannot sue or be sued, own property in its own name, or file its own tax returns. The business owner (proprietor) personally owns all of the assets of the business and controls its operation. If you're running a one-person business and you haven't incorporated or formed a limited liability company, you are a sole proprietor.
A partnership is a form of shared ownership and management of a business. The partners contribute money, property, or services to the partnership; in return, they receive a share of the profits it earns, if any. The partners jointly manage the partnership business. A partnership automatically
comes into existence whenever two or more people enter into business together to earn a profit and don't incorporate or form a limited liability company. Although many partners enter into written
partnership agreements, no written agreement is required to form a partnership.
Unlike a sole proprietorship or partnership, a corporation cannot simply spring into existence -- it can only be created by filing incorporation documents with your state government. A corporation is a legal entity distinct from its owners. It can hold title to property, sue and be sued, have bank accounts, borrow money, hire employees, and perform other business functions.
For tax purposes, there are two types of corporations: S corporations (also called small business corporations) and C corporations (also called regular corporations). The most important difference between the two types of corporations is how they are taxed. An S corporation pays no taxes itself -- instead, its income or loss is passed on to its owners, who must pay personal income taxes on their share of the corporation's profits. A C corporation is a separate taxpaying entity that pays taxes on
its profits. (See "Tax Treatment," below.)
Limited Liability Company
The limited liability company, or LLC, is the newest type of business form in the United States. An LLC is like a sole proprietorship or partnership in that its owners (called members) jointly own and manage the business and share in the profits. However, an LLC is also like a corporation,
because its owners must file papers with the state to create the LLC, it exists as a separate legal entity, and the LLC structure gives owners some protection from liability for business debts.
Your business's legal form will determine how it is treated for tax purposes. There are two different ways that business entities can be taxed: The business itself can be taxed as a separate entity, or the business's profits and losses can be "passed through" to the owners, who include the profits or losses on their individual tax returns.
Pass-Through Entities: Sole Proprietorships, Partnerships, LLCs, and S Corporations
Sole proprietorships and S corporations are always pass-through entities. LLCs and partnerships are almost always pass-through entities as well -- partnerships and multiowner LLCs are automatically taxed as partnerships when they are created. One-owner LLCs are automatically taxed like sole proprietorships. However, LLC and partnership owners have the option of choosing to have their entity taxed as a C corporation or S corporation by filing an election with the IRS. This is rarely done.
A pass-through entity does not pay any taxes itself. Instead, the business's profits or losses are passed through to its owners, who include them on their own personal tax returns (IRS Form 1040). If a profit is passed through to the owner, that money is added to any other income the owner has and the owner pays taxes on the total amount. If a loss is passed through, the owner can generally use it to offset income from other sources -- for example, salary from a job, interest, investment income,
or a spouse's income (as long as the couple files a joint tax return). The owner can subtract the business loss from this other income, which leaves a lower total subject to tax.
Example: Lisa is a sole proprietor who works part time as a personal trainer. During her first year in business, she incurs $10,000 in expenses and earns $5,000, giving her a $5,000 loss from her business. She reports this loss on IRS Schedule C, which she files with her personal income tax return (Form 1040). Because Lisa is a sole proprietor, she can deduct this $5,000 loss from any
income she has, including her $100,000 annual salary from her engineering job. This saves her about $2,000 in total taxes for the year.
Although pass-through entities don't pay taxes, their income and expenses must still be reported to the IRS as follows:
Posted February 16, 2012
This book was helpful in listing many deductions that small businesses need to use when filing their taxes. It's easy to use, and a great quick reference.Was this review helpful? Yes NoThank you for your feedback. Report this reviewThank you, this review has been flagged.
Posted December 31, 2010
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Posted December 4, 2010
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