When starting, a new business must select a business structure, which will have both legal and tax implications. And, the choice of business structure is a monumental step for a new company. It can affect ongoing costs, liability and how your business team can be configured. This topic becomes particularly timely during tax season, as your business’ structure has direct tax implications. Show
Have no fear: Below, we outline the most common types of business structures and their respective tax ramifications. What Is a Business Structure?A business structure is a type of legal organization of a business. When starting a new business, it’s important to take time to decide on the right type of business entity. The business structure you choose doesn’t have a lot of impact on the day-to-day operation of your business, but it is extremely important in defining ownership, limiting personal liability, managing business taxes, and preparing for future growth. At a basic level, business entities establish the business as a legal entity that can have bank accounts, enter into contracts, and conduct business without putting everything in your own name. For some very small businesses, working under your own name may be okay, but if you plan to earn a full-time income from the business, sign contracts, or hire employees, it’s likely in your best interest to choose a business structure and register with your state. Key Takeaways
Business Structures ExplainedIf you’ve ever had a job, rented a home, or bought a car, you likely signed a contract where you were acting as yourself. However, on the other side of the contract, the signature lines may show someone signing on behalf of a business. For that business to enter into a contract, it must use a recognized business structure and maintain an active registration with the state government. When you sign a contract or do business as yourself, which is the default if you start a business and don’t register, you are personally liable for anything that goes wrong. If you make a mistake with a client or someone is injured by your product or service, you could be personally liable for any financial damages. That means they can sue you and go after your personal bank accounts, investments, home, and other assets in the suit. When you operate a registered business and follow best practices, your personal assets are protected. By default, your business is considered a sole proprietorship, where you are the business and transact under your own name. When you create an LLC, corporation, or partnership, that new entity takes your place on contracts. Once you reach a certain income level, if you’re running the business full-time, there are additional tax benefits as well. However, business entities are not free. Every state requires different fees to start and maintain a business. You may be able to file the registration paperwork on your own, but many people choose to hire a lawyer to ensure the business is created correctly and stays in compliance with local, state, and federal laws. Because every business and business owner is unique, it may be worthwhile to consult with a legal or tax professional for advice on choosing the best business structure for your long-term goals. What Are the Four Types of Business Structures?1. Sole proprietorshipA sole proprietorship is the most common type of business structure. As defined by the IRS, a sole proprietor “is someone who owns an unincorporated business by himself or herself.” The key advantage in a sole proprietorship lies in its simplicity. Here, there is no distinction between the business and the individual who owns it — which means that the owner is entitled to all profits. However, it also means that the sole proprietor is responsible for all the business’s debts, losses and liabilities. This means that creditors or lawsuit claimants may have access to the business owner’s personal accounts and assets if the business accounts cannot cover the debt. Examples of sole proprietorship include freelance writers, independent consultants, tutors and caterers. Overview of liabilitiesLiabilities are defined as a company’s financial debts or obligations that arise during business operations. Limited liability is a type of legal structure where a corporate loss will not exceed the amount invested in a partnership or LLC. In other words, investors’ and owners’ private assets are not at risk if the company fails. So, if a company with limited liability is sued, then the claimants are suing the company; personal assets can’t be touched. Whereas personal liability is when a business owner’s assets can be used to satisfy any business debts. However, "piercing the corporate veil" is the most common in close corporations to settle debts and can occur when serious misconduct takes place. This is when courts put aside limited liability and hold a company’s shareholders personally liable for the corporation’s actions or debts. Pass-through entityIn terms of tax implications, sole proprietorships are considered a “pass-through entity.” Also known as a “flow-through entity” or “fiscally transparent entity,” this means that the business itself pays no taxes. Instead, taxes are “passed through” to the owner. Pass-through entities are not subject to corporate income tax. Profits pass through to owners who pay them in their personal returns under ordinary income tax rates on the typical Tax Day, usually April 15. Pros:
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2. PartnershipIn business structure, a partnership is “the relationship existing between two or more persons who join to carry on a trade or business.” Partnerships have three common types of classifications: a general partnership, limited partnership or a limited liability partnership.
Like a sole proprietorship, partnerships are considered a pass-through entity when it comes to taxation. In many ways, a partnership is like an expanded sole proprietorship — but with the advantages and disadvantages that comes with a partner. A partner can provide expertise, skills and capital for the business. But while they can affect the business positively, they can also impact it negatively. You should be comfortable with whomever you enter into business with. Partnership tax returns are due the fifteenth day of the third month after the end of the entity’s tax year, which is typically March 15 (or March 16 in 2020). However, while the taxes are filed in March, partners don’t tend to pay taxes on the business until the April deadline (July 15 in 2020) since it passes through to their personal tax return. Pros:
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3. Limited liability companyNow, a limited liability company (LLC) is where things start to get a little dicey. The IRS states that an LLC is a “business structure allowed by state statute.” That means it is formed under state law and the regulations surrounding LLCs vary from state to state. Depending on elections made by the LLC and its characteristics, the IRS will treat an LLC as either a corporation, partnership or as part of the LLC’s owner’s tax return (i.e. a “disregarded entity” with many of the characteristics of a sole proprietorship). An LLC is considered a hybrid legal entity because it has traits of numerous other business structures, depending on the elections made by the owners. This lends it more protections and flexibility than some of its business structure counterparts. From a protections perspective, members of an LLC are not personally liable. Because the LLC is an entity created by state statute, it has flexibility in regards to federal tax treatment. For instance, a single-member LLC can be taxed as a sole proprietorship or a corporation. A multi-member LLC can be taxed as a partnership or a corporation. The aforementioned flexibility causes some discrepancies when it comes to the federal tax due date.
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4. CorporationCorporations are a company or group of people authorized to act as a single legal entity. This means that the company is considered separate and distinct from its owners (i.e. there’s no personal liability here). However, a corporation is eligible for many of the rights that individuals possess, hence why it is sometimes referred to as a “legal person.” For instance, a corporation can sue or be sued, enter into contracts and is entitled to free speech. The IRS splits corporations into two separate classifications: the “C corporation” and the “S corporation.”
Like partnerships, an S corporation must always file its annual federal tax return by the fifteenth day of the third month following the end of the tax year, generally March 15. The income is then passed down to its members individual returns, which adhere to the normal April Tax Day. Corporations are the only business tax structure allowing for perpetual existence. This means that its continuance is not affected by the coming and going of shareholders, officers and directors. Pros:
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What Are the Tax Pros and Cons of Each Business Structure?Business structureTax prosTax consSole proprietorship
Choosing a Business StructureThe best business structure for your company depends on your long-term goals, ownership, plans to hire employees, and legal risk. While some very small businesses and side hustles may operate safely as a sole proprietorship, most businesses are better off registering a business with their state. The best business structure for businesses that don’t plan to bring in outside investments is often an LLC, as it works for one or more owners with lower startup and maintenance requirements than a full corporation. If your business employs one or more owner full-time, it could make sense to register as an LLC and opt for taxation as an S Corporation. If you plan to bring in outside investment rounds and may grow into a publicly traded company in the future, the best business structure is a C Corporation, as that structure allows for 100 or more shareholders. Because of the important tax and legal implications, it’s often well worth the cost to consult with an attorney or tax expert for advice on the best business structure for your needs and goals. #1 Cloud ERP ConclusionChoosing a legal business structure is a critical step in your business's lifecycle. It affects everything from the ability to attract investors to personal liability and government paperwork. Businesses owners should weigh their own personal circumstances and long-term business goals against the costs to pick the best possible legal structures. Once you have that important decision locked in, it's back to focusing on what's most important: running your day-to-day operation for maximum business profits. What type of business is two or more people?A partnership (or general partnership) is a business owned jointly by two or more people.
What is the type of business structure when two or more individuals agree to own and operate a business together multiple choice question?Partnership. Partnerships are the simplest structure for two or more people to own a business together. There are two common kinds of partnerships: limited partnerships (LP) and limited liability partnerships (LLP).
What business organization is owned by two or more individuals?Partnerships. In a Partnership, two or more people share ownership of a single business. Like proprietorships, the law does not distinguish between the business and its owners.
What is it called when a business is owned by multiple people?A partnership is a business structure made up of 2 or more people who distribute income or losses between themselves.
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