Type of Corporations for Small Business
There are five types of corporations for small business to select from. They include sole proprietorship, partnership, LLC, C corporation, and S corporation.3 min read
There are five types of corporations for small business to select from. They include sole proprietorship, partnership, LLC, C corporation, and S corporation.
Forming a sole proprietorship is considered the simplest business structure to create. Generally, it involves only one party who owns and operates the business. This structure is ideal for individuals who prefer to work alone. The key advantage to being taxed as a sole proprietorship is that net income from the business is taxed on the personal income tax return of the owner on Form 1040.
Losses and profits will be recorded on the Schedule C tax form, which is always filed with Form 1040. The net income of the business is taken from Schedule C and transported to the personal tax return of the owner. This aspect of a sole proprietorship is appealing to many owners because any losses incurred by the business can be offset against any other personal income.
Paying taxes correctly for a sole proprietorship will include filing Schedule SE on your Form 1040. The Schedule SE is used to calculate the self-employment tax due to the IRS. Unlike many other business structures, a sole proprietorship is only taxed once, on the personal income tax return of the owner.
Being at risk of unlimited liability is the most significant disadvantage of selecting to form a business as a sole proprietorship. In other words, an owner's personal assets may be liable for the liabilities of the business. As a consequence, the personal assets of the owner are at risk. They may be seized by a creditor to satisfy the legal claims or debts of the business.
It can be difficult for sole proprietorships to raise capital. Many banks are apprehensive to make a loan to a sole proprietorship. In other words, small business owners will need to rely on their own methods to finance the company, such as:
- Family loans
- Home equity loans
States do not currently require sole proprietorships to register with them. However, you still may need to request local business licenses or permits depending on the industry.
There are two types of partnerships:
- General partnership
- Limited partnership
A Partnership Agreement is an agreement between two or more individuals who would like to manage and operate a business together in order to make a profit. Partnership Agreements help to resolve and prevent disputes between owners.
Stockholders, officers, and the board of directors have total authority over the corporation. However, it is possible for an individual to fulfill all three roles. In other words, it's possible to start a corporation and be in complete charge of every aspect of the business. Corporations continue indefinitely and won't dissolve even when a stockholder:
- Becomes disabled
- Sells shares in the business
An experienced attorney can help guide you through the corporate law governed by each state. Remember, each state may have its own requirements and regulations. A significant disadvantage to forming a corporation is the number of formalities that need to be met, including:
- Creating bylaws
- Shareholder meetings
- Board meetings
- Acknowledging meeting minutes
S corporations pass the net income of the business onto the stockholders of the business in order for them to be taxed on their personal tax returns. Essentially, there's only one tier of federal income tax to pay.
Limited Liability Companies
An LLC is taxed in a similar fashion, except LLCs provide owners with even more benefits. For example, an LLC can have an unlimited number of stockholders.
Advantages of an LLC
The simplicity of completing taxes is a key advantage for an LLC. The net income from the business is recorded on the personal income tax return of the member. Only in cases where the LLC has more than one member and decides to be taxed as a partnership will they need to file a separate business tax return on Form 1065. The other advantage for filing as an LLC is that the business will not incur double taxation. In a corporation, both the stockholders and the business are taxed.
Disadvantages of an LLC
When compared to a sole proprietorship, there is more paperwork required for an LLC. However, it is still far less when compared to a corporation. One-time filings include:
- Tax status on Form 8832
- Application for Employer ID on Form SS-4
Other reoccurring filings or paperwork that will need to be completed, include:
- Quarterly reports
- Annual reports
- Opening a business bank account
- Tax deposit coupons
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