Forms
of Ownership
One
of the first decisions that you will have to make
as a business owner is how the company should
be structured. This decision will have long-term
implications, so consult with an accountant and
attorney to help you select the form of ownership
that is right for you. In making a choice, you
will want to take into account the following:
- Your
vision regarding the size and nature of your
business.
- The
level of control you wish to have.
- The
level of structure you are willing to deal with.
- The
business' vulnerability to lawsuits.
- Tax
implications of the different ownership structures.
- Expected
profit (or loss) of the business.
- Whether
or not you need to reinvest earnings into the
business.
- Your
need for access to cash out of the business
for yourself.
Sole
Proprietorships
The
vast majority of small businesses start out as
sole proprietorships. These firms are owned by
one person, usually the individual who has day-to-day
responsibilities for running the business. Sole
proprietors own all the assets of the business
and the profits generated by it. They also assume
complete responsibility for any of its liabilities
or debts. In the eyes of the law and the public,
you are one in the same with the business.
Advantages
of a Sole Proprietorship
- Easiest
and least expensive form of ownership to organize.
- Sole
proprietors are in complete control, and within
the parameters of the law, may make
- decisions
as they see fit.
- Sole
proprietors receive all income generated by
the business to keep or reinvest.
- Profits
from the business flow directly to the owner's
personal tax return.
- The
business is easy to dissolve, if desired.
Disadvantages
of a Sole Proprietorship
- Sole
proprietors have unlimited liability and are
legally responsible for all debts against the
business. Their business and personal assets
are at risk.
- May
be at a disadvantage in raising funds and are
often limited to using funds from personal savings
or consumer loans.
- May
have a hard time attracting high-caliber employees
or those that are motivated by the opportunity
to own a part of the business.
- Some
employee benefits such as owner's medical insurance
premiums are not directly deductible from business
income (only partially deductible as an adjustment
to income).
Federal
Tax Forms for Sole Proprietorship
(only a partial list and some may not apply)
- Form
1040: Individual Income Tax Return
- Schedule
C: Profit or Loss from Business (or Schedule
C-EZ)
- Schedule
SE: Self-Employment Tax
- Form
1040-ES: Estimated Tax for Individuals
- Form
4562: Depreciation and Amortization
- Form
8829: Expenses for Business Use of your Home
- Employment
Tax Forms
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. The partners should have a legal
agreement that sets forth how decisions will be
made, profits will be shared, disputes will be
resolved, how future partners will be admitted
to the partnership, how partners can be bought
out, and what steps will be taken to dissolve
the partnership when needed. Yes, it's hard to
think about a breakup when the business is just
getting started, but many partnerships split up
at crisis times, and unless there is a defined
process, there will be even greater problems.
They also must decide up-front how much time and
capital each will contribute, etc.
Advantages
of a Partnership
- Partnerships
are relatively easy to establish; however time
should be invested in developing the partnership
agreement.
- With
more than one owner, the ability to raise funds
may be increased.
- The
profits from the business flow directly through
to the partners' personal tax returns.
- Prospective
employees may be attracted to the business if
given the incentive to become apartner.
- The
business usually will benefit from partners
who have complementary skills.
Disadvantages
of a Partnership
- Partners
are jointly and individually liable for the
actions of the other partners.
- Profits
must be shared with others.
- Since
decisions are shared, disagreements can occur.
- Some
employee benefits are not deductible from business
income on tax returns.
- The
partnership may have a limited life; it may
end upon the withdrawal or death of a partner.
Types
of Partnerships that should be considered:
- General
Partnership
Partners divide responsibility for management
and liability as well as the shares of profit
or loss according to their internal agreement.
Equal shares are assumed unless there is a written
agreement that states differently.
- Limited
Partnership and Partnership with limited liability
Limited means that most of the partners have
limited liability (to the extent of their investment)
as well as limited input regarding management
decisions, which generally encourages investors
for short-term projects or for investing in
capital assets. This form of ownership is not
often used for operating retail or service businesses.
Forming a limited partnership is more complex
and formal than that of a general partnership.
- Joint
Venture
Acts like a general partnership, but is clearly
for a limited period of time or a single project.
If the partners in a joint venture repeat the
activity, they will be recognized as an ongoing
partnership and will have to file as such as
well as distribute accumulated partnership assets
upon dissolution of the entity.
Federal
Tax Forms for Partnerships
(only a partial list and some may not apply)
- Form
1065: Partnership Return of Income
- Form
1065 K-1: Partner's Share of Income, Credit,
Deductions
- Form
4562: Depreciation
- Form
1040: Individual Income Tax Return
- Schedule
E: Supplemental Income and Loss
- Schedule
SE: Self-Employment Tax
- Form
1040-ES: Estimated Tax for Individuals
- Employment
Tax Forms
Corporations
A
corporation chartered by the state in which it
is headquartered is considered by law to be a
unique entity, separate and apart from those who
own it. A corporation can be taxed, it can be
sued, and it can enter into contractual agreements.
The owners of a corporation are its shareholders.
The shareholders elect a board of directors to
oversee the major policies and decisions. The
corporation has a life of its own and does not
dissolve when ownership changes.
Advantages
of a Corporation
- Shareholders
have limited liability for the corporation's
debts or judgments against the corporations.
- Generally,
shareholders can only be held accountable for
their investment in stock of the company. (Note
however, that officers can be held personally
liable for their actions, such as the failure
to withhold and pay employment taxes.)
- Corporations
can raise additional funds through the sale
of stock.
- A
corporation may deduct the cost of benefits
it provides to officers and employees.
- Can
elect S corporation status if certain requirements
are met. This election enables company to be
taxed similar to a partnership.
Disadvantages
of a Corporation
- The
process of incorporation requires more time
and money than other forms of organization.
- Corporations
are monitored by federal, state and some local
agencies, and as a result may have more paperwork
to comply with regulations.
- Incorporating
may result in higher overall taxes. Dividends
paid to shareholders are not deductible from
business income; thus it can be taxed twice.
Federal
Tax Forms for Regular or "C" Corporations
(only a partial list and some may not apply)
- Form
1120 or 1120-A: Corporation Income Tax Return
- Form
1120-W Estimated Tax for Corporation
- Form
8109-B Deposit Coupon
- Form
4625 Depreciation
- Employment
Tax Forms
- Other
forms as needed for capital gains, sale of assets,
alternative minimum tax, etc.
Subchapter
S Corporations
A
tax election only; this election enables the shareholder
to treat the earnings and profits as distributions
and have them pass through directly to their personal
tax return. The catch here is that the shareholder,
if working for the company, and if there is a
profit, must pay him/herself wages, and must meet
standards of "reasonable compensation".
This can vary by geographical region as well as
occupation, but the basic rule is to pay yourself
what you would have to pay someone to do your
job, as long as there is enough profit. If you
do not do this, the IRS can reclassify all of
the earnings and profit as wages, and you will
be liable for all of the payroll taxes on the
total amount.
Federal
Tax Forms for Subchapter S Corporations
(only a partial list and some may not apply)
- Form
1120S: Income Tax Return for S Corporation
- 1120S
K-1: Shareholder's Share of Income, Credit,
Deductions
- Form
4625 Depreciation
- Employment
Tax Forms
- Form
1040: Individual Income Tax Return
- Schedule
E: Supplemental Income and Loss
- Schedule
SE: Self-Employment Tax
- Form
1040-ES: Estimated Tax for Individuals
- Other
forms as needed for capital gains, sale of assets,
alternative minimum tax, etc.
Limited
Liability Company (LLC)
The
LLC is a relatively new type of hybrid business
structure that is now permissible in most states.
It is designed to provide the limited liability
features of a corporation and the tax efficiencies
and operational flexibility of a partnership.
Formation is more complex and formal than that
of a general partnership.
The
owners are members, and the duration of the LLC
is usually determined when the organization papers
are filed. The time limit can be continued, if
desired, by a vote of the members at the time
of expiration. LLCs must not have more than two
of the four characteristics that define corporations:
Limited liability to the extent of assets, continuity
of life, centralization of management, and free
transferability of ownership interests.
Federal
Tax Forms for LLC
Taxed
as partnership in most cases; corporation forms
must be used if there are more than 2 of the
4 corporate characteristics, as described above.
In
summary, deciding the form of ownership that best
suits your business venture should be given careful
consideration. Use your key advisers to assist
you in the process.
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