Sole Proprietorships
The most simple is the sole proprietorship. Generally there are almost no
requirements to form a sole proprietorship, which can only be formed by a single
owner. You may not even need an employer identification number (EIN) from the
IRS if you have no employees and issue no 1099 forms. You may also freely remove
funds from the business account into your personal checking account without
worrying about any tax consequences. Tax losses are also unlimited.
The major disadvantage is that profits are subject to both income and
self-employment taxes, making the lowest federal tax rate 30.3% on these
profits. Also, sole proprietors are liable for quarterly estimated tax deposits,
which can prove to be financially burdensome. However, there are some neat
family tax benefits to a sole proprietorship.
Partnerships
The partnership form is for companies with multiple owners. The two most common
types of partnerships are the general partnership (where every partner is fully
liable for 100% of all partnership activities and liabilities), and the limited
partnership (where one general partner is fully exposed to unlimited liability,
but the limited partners have their liability exposure capped to the amount of
their investment). Partnerships are becoming less common with the rise of the
relatively new limited liability company form of organization.
Partnerships can be formed by oral agreement. To protect yourself, however,
you should file a signed copy of a written partnership agreement at the county
clerk's office. Partnerships will need a federal EIN number and must file an
annual partnership tax return, but are generally free of most paperwork
requirements. The partnership itself pays no income taxes, but each partner gets
a form K-1 allocating his or her share of profits to be included on the
partners' personal returns.
Partnerships are used today for simple business startups, and family holding
organizations used to pass on assets to heirs in a tax advantaged manner. Also,
real estate deals can be structured as limited partnerships.
Corporations
Corporations are "artificial beings" that are recognized by law as
having a separate status from their owners and, therefore, offer limited
liability protection. Most small businesses have formed corporations during the
past 10 years or so to obtain limited liability coverage. Forming a corporation
has become very easy. You can either pay a lawyer to do it, or for a much
reduced price, contact your state Secretary of State Corporations Division for
the appropriate one page fill-in-the-blank form. Corporations must also hold at
least one annual stockholders meeting and one board of directors meeting. Most
office supply stores sell fill-in-the-blank forms for these meetings for a very
modest price, so you can be fully in compliance with state law for a very low
cost.
For profit corporations can have one or more shareholders. Many small
businesses are one-person operations.
There are two types of for-profit corporations for tax purposes. The
Subchapter "C" corporation pays its own income taxes. While dividends
are double taxed, you can load up on fringe benefit plans. Subchapter
"S" corporations must file an income tax return, but almost always pay
no income taxes. Instead the shareholders receive a form K-1 allocating their
share of profits to their personal tax returns. The big advantage of the
"S" corporation is the ability to avoid self-employment taxes on a
portion of the profits, and have greater flexibility in extracting profits.
The general disadvantages to corporations are the additional formal
paperwork, some tax limitations on deducting losses, various limitations on
distribution of dividends, and higher operating costs (primarily corporate
taxes) and preparation fees for corporate returns.
