Finding the best legal structure for your business

In the last few weeks, I have several folks asking about what is the best type of entity to use for their business. Consequently, I thought we could revisit a blog from May 2016.

Are you considering starting a new business? One of the decisions you will need to make is what type of business entity to use. Here is some basic information on the main (legal) entity types.

Sole Proprietorship

Advantages:

• This is the simplest type of business entity.
• No legal documents for starting the business.
• No separate tax return. You will report your income and expenses on Schedule C of your individual tax return (Form 1040).

Disadvantages:

• Liability — If someone is injured on your business premises or because your actions, your business or your employees, and your business liability does not cover all of the loss, you are personally liable. This means they can take all of your business assets and if that is not enough, take your personal assets, also.
• All income is subject to self-employment tax.
• The obvious one — there can only be one owner (this might be an advantage, depending on your perspective).

C Corporation

Disadvantages:

• This is the most complicated type of business entity.
• Legal documents required for starting the business.
• Separate tax return (Form 1120).
• Double taxation:
  • Corporation pays tax on the income reported on Form 1120.
  • Shareholders pay tax on dividends received from the corporation.

Advantages:

• No limit on number of shareholders (owners).
• No personal liability. Maximum loss for shareholders is what they paid for the stock.
• Corporation’s net income is not subject to self-employment tax.

Partnership

Disadvantages:

• Legal documents necessary to memorialize the expectations of the partners.
• Separate tax return (Form 1165).
• All income of the partnership subject to self-employment tax.
• Personal liability for all partners unless the partnership is set up as a limited partnership.
• Partners pay tax on their share of the partnership income even if the income is not distributed to them.

Advantages:

• Simplest type of business entity if there are two or more owners in the business.
• No double taxation on distributions received from the partnership.

S Corporation

Advantages:

• Personal liability limited to amount invested in the corporation.
• No double taxation on distributions received from the corporation.
• If owner(s) receive a “reasonable” salary from the corporation, other income of the S Corporation may not be subject to self-employment tax.

Disadvantages:

• Legal documents required for starting the business but not as complicated as for a C Corporation.
• Separate tax return (Form 1120S).
• Shareholders pay tax on their share of the S Corporation income even if they don’t receive any distributions from the S Corporation.
• Limits on number of shareholders (owners) and shareholder types.

Limited Liability Company (LLC)

Advantages:

• Personal liability limited to amount invested in the LLC.
• No double taxation on distributions received from the LLC.
• If the LLC is a single-member LLC, the owner can decide whether to file their income taxes as sole proprietor or S Corporation.
  • Sole-proprietor:
    • No separate tax return.
    • Report income and expenses on Schedule C of Form 1040.
  • S Corporation:
    • Separate tax return (Form 1120S).
    • Need to file Form 2553 to make the S Corporation election.
    • If owner receives a “reasonable” salary from the LLC, other income of the LLC is not subject to self-employment tax.
• If the LLC has two or more members, the owners can decide whether to file their income taxes as a partnership or S Corporation.
  • Partnership:
    • Separate tax return (Form 1165).
  • S Corporation:
    • Separate tax return (Form 1120S).
    • Need to file Form 2553 to make the S Corporation election.
    • If owners receive a “reasonable” salary from the LLC, other income of the LLC is not subject to self-employment tax.

If you need help evaluting your options for your company, please give me a call at 402-504-3497 to set up an appointment. I’ll be happy to help you walk through the details.

Judith Ackland has more than 26 years of experience in accountancy and financial planning, including seventeen years as a CFO of a diverse business. She started Crystal Financial in 2010 to help a wide array of individuals, families, and business owners better understand their finances and how good financial management could help them achieve their goals. Judith has an MA in Professional Accountancy from the University of Nebraska at Lincoln as well as a Certified Public Accountant Certificate and a Certified Financial Planner designation.