Business Structure Guide

This business structure guide was developed by Metro Accounting and Tax Services, CPA, with a view of helping current and prospective business owners decide on the business structure that’s in-line with their business goals and the one that will provide the greatest tax benefit.

When going into business it is important to select the correct form of business structure you want to establish. This decision can have many life and tax related consequences if not done properly. The type of entity formed will determine among other things, which income tax form or forms you’ll have to file.

The most common types of business structures are: Sole Proprietorship, Partnership, Corporation, S Corporation and Limited Liability Company (LLC).

Sole Proprietorship

A sole proprietor is someone who owns an unincorporated business by himself or herself. A sole proprietor has unlimited liability for the debts of the company. However, if you are the sole member of a domestic limited liability company (LLC), you are not a sole proprietor if you elect to treat the LLC as a corporation.

A sole proprietor who is liable for:

1) Income tax generally uses form 1040, that is U.S Individual Tax Return and Schedule C (Form 1040) Profit or Loss from Business or Schedule C-EZ (Form 1040), Net Profit from Business.

2) Self-employment tax uses Schedule SE (Form 1040).

3) Estimated taxes files Form 1040-ES.

4) Social security and Medicare taxes and all income tax withholdings files Form 941, Employer’s Quarterly Federal Tax Return, Form 943, Employer’s Annual Federal Tax Return for Agricultural Employees and Form 944 for the Employer’s Annual Federal Tax Return.

5) For providing information on Social security and Medicare tax withholdings, files Form W-2, wage and tax Statement prepared for employees and Form W-3, Transmittal of Wages and Tax Statements is provided to the Social Security Administration.

6) For Federal unemployment tax (FUTA), files Form 940, Employer’s Annual Federal Unemployment Tax Return.

Partnership

A partnership is the business engagement of two or more persons with the goal of carrying on a trade or business with the intent to make a profit. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.

A partnership must file an annual information return to report the income, deductions, gains, losses from its operations as it does not pay income tax. Instead, any gains or losses are “passes through” to the partners according to their profit sharing agreement.  Each partner includes his or her share of the partnership’s income or loss on his or her individual tax return.

Partners are not employees of the partnership, they are owners and they are not issued Form W-2. Instead a partnership must furnish copies of Schedule K-1 (Form 1065) to the partners by the required filling due date. The K-1 basically record the Partner’s share of profit or loss over the period.

A partnership or a partner may use the following forms for tax purposes depending of their individual situation:

1)    Annual tax return for the partnership uses Form 1065, U.S, Return of Partnership Income.

2)    For the filling of employment taxes, use Form 941, Employer’s Quarterly Federal Tax Return and Form 943, Employer’s Annual Federal Tax Return for Agricultural purposes.

Partners in a partnership may be required to file:

1)    Income Tax –  Form 1040, Individual Income Tax Return and Schedule E, Supplemental Income and Loss (Form 1040).

2)    Self-employment tax – Schedule SE (Form 1040)

3)    Estimated tax – 1040-ES, Estimated Tax for Individuals

Corporation

A Corporation is made up of shareholders. Prospective shareholders exchange money, property, or both, for the corporation’s capital stock. A corporation generally takes the same deductions as a sole proprietorship to figure its taxable income. A corporation can also take special deductions.

From an income tax perspective, a corporation is recognized as a separate taxpaying entity. The corporation conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders. Shareholders are limited to their contributed capital for the liability of the company.

The profit of the corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. This creates a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any losses of the corporation.

Forms that might be required to be filled by the corporation includes:

1) For Income Tax – 1120, U.S. Corporation Income Tax Return

2) For Estimated Tax – 1120-W, Estimated Tax for Corporations

3) For Employment Taxes – 941, Employer’s Quarterly Federal Tax Return, or 943, Employer’s Annual Federal Tax Return for Agricultural Employees

4) Unemployment tax – 940, Employer’s Annual Federal Unemployment (FUTA) Tax return

S Corporation

It is important to note that a S Corporation is firstly another business structure that elects to be treated as a S Corporation for tax purposes. So, we might have a corporation that elects to be treated as a S corporation to avoid paying taxes twice. With the S corporation status, corporate income, losses, deductions, and credits are passed through to the shareholders for federal tax purposes. Shareholders of S corporation report the flow-through income and losses on their personal tax returns and are assess tax at their individual income tax rates.

This allows the S corporation to avoid double taxation on corporate income, that is at the corporate level and then at the dividend level. This is one of the advantages why corporations often times make the S election.

S corporations are responsible for tax on certain built-in gains and passive income at the entity level.

To qualify for S corporation status, the corporation must meet the following requirements:

• Be a domestic corporation
• Have only allowable shareholders
  • May be individuals, certain trusts, and estates and
  • May not be partnerships, corporations or non-resident alien shareholders
• Have no more than 100 shareholders
• Have only one class of stock
• Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).

The election to S status is done by the corporation submitting Form 2553, Election by a Small Business Corporation. This form must be signed by all the shareholders.

Forms that might be required to be filled by the S-corporation includes:

1) For Income Tax – 1120S, U.S. Corporation Income Tax Return, 1120s Sch. K-1

2) For Estimated Tax – 1120-W, Estimated Tax for Corporations and 8109

3) For Employment Taxes – 941, Employer’s Quarterly Federal Tax Return, or 943, Employer’s Annual Federal Tax Return for Agricultural Employees

4) Unemployment tax – 940, Employer’s Annual Federal Unemployment (FUTA) Tax return,

Forms that might be required to be filled by the S-corporation Shareholders.

1) For Income Tax – 1040 & Schedule E or other forms referenced on the K-1.

2) For Estimated Tax – 1040 ES

Limited Liability Company (LLC)

A Limited Liability Company (LLC) is a business structure allowed by state statute. As of such, each state may use different regulations, and it is imperative that you check with the state in which you want to form your Limited Liability Company for their regulations.

Owners of a LLC are called members. Most states do not restrict ownership, and so members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Most states also permit “single-member” LLCs, those having only one owner.

However, a few types of businesses generally cannot be LLCs. These includes banks and insurance companies. Again, please check your state’s requirements and the federal tax regulations before you proceed.

Classifications

The IRS will treat a LLC as either a corporation, partnership, or as part of the LLC’s owner’s tax return (a “disregarded entity”), depending on elections made by the LLC and the number of members it has.

A two-member domestic LLC is classified as a partnership for federal income tax purposes unless it files Form 8832 and affirmatively elects to be treated as a corporation.

A LLC with only one member is treated as a disregarded entity as separate from its owner for income tax purposes (but as a separate entity for purposes of employment tax and certain excise taxes), unless it files Form 8832 and affirmatively elects to be treated as a corporation.

Entity Classification Election

An LLC that does not want to accept its default federal tax classification, or that wishes to change its classification, uses Form 8832, Entity Classification Election, to elect how it will be classified for federal tax purposes. Generally, an election specifying an LLC’s classification cannot take effect more than 75 days prior to the date the election is filed, nor can it take effect later than 12 months after the date the election is filed. An LLC may be eligible for late election relief in certain circumstances.

User | 31/10/2017