America is built on entrepreneurial chutzpah. Starting one’s own business may not be for the faint of heart, but knowing how to structure that business does not have to be the stuff of nightmares. The choice of forming a sole proprietorship, a partnership, a corporation, or an S Corporation merits careful consideration. The choice of business entity dictates how income and expenses will be reported to IRS and applicable states.
What Each Business Entity Type Means
They are not to be confused with LLC, a Limited Liability Company. Forming an LLC is often wise because it separates the business owner(s) from the business for liability purposes. LLCs may report their income as a sole proprietorship, a partnership, or an S Corporation. No need to have your home and other assets at risk for your business—safeguard your personal wealth by forming an LLC. You will still have to decide how to report your income. Let’s go over how that works.
Sole Proprietorships report income on the owner’s personal tax return on Schedule C. This can be reported under the owner SSN if no business has been formed. This is the simplest way to report business income since the business does not file its own tax return and yours truly doesn’t have to track down your balance sheet.
Partnerships report income on their own tax return, Form 1065. While the partnership tax return is separate from the partners’ individual tax returns, the partners get a K-1 from the business. This allocates the income to the partners based on partnership percentages. One benefit of partnerships is that guaranteed payments can be made to partners and expensed. The payments are not to be confused with distributions. Guaranteed payments are regularly made and in scheduled amounts. Distributions can be occasionally, frequently, or never—they are not expenses.
A C-corporation, a ‘regular’ corporation, pays its own taxes on Form 1120. A corporation pays taxes on its profits and its shareholders pay taxes on their dividends. Shareholders are not able to deduct any of the business losses. Usually a hard pass—not very appealing.
Now an S Corporation differs from a Corporation in some very appealing ways. The profit or loss flows to the shareholders on K-1s. This allows the shareholders to deduct losses and prevents double taxation. Keep in mind that shareholders of an S Corporation must earn reasonable compensation from the company. Good news: the business can deduct the wages as well as the payroll tax expense. Even better news: payroll taxes are considered timely paid even if the payroll is not paid until December. Let us do tax planning to determine your tax liability and you can pay your taxes later in the year without keeping your money tied up in quarterly estimated taxes.
Owning a business has myriad decisions. Let S&K help you choose wisely when it comes to setting up your business.