A Closer Look at the Different Types of Businesses
Policywire by AmTrust
Exploring the Common Forms of Business Organizations
Entrepreneurs may face a variety of challenges as they get their new business venture up and running. Before they begin hiring employees, determining budgets or creating marketing strategies, they first must decide what type of business they will classify as. This important step affects how much new business owners will pay in taxes, the type of paperwork to complete, how they can raise money and their personal liability in the company.
There are legal and tax ramifications, as well as differing costs of formation and operation, to consider when choosing a business type, so it's recommended that entrepreneurs speak to a professional for expert advice when starting out.
Filing Business Taxes
Each different type of business organization will require specific forms when filing taxes, and the IRS website offers a detailed breakdown of how to file business taxes, including deadlines and necessary forms. There are five main types of business taxes:
Income tax: The federal income tax is paid on income earned throughout the year, and it is required for all business types except partnerships. The form used depends on how the business is organized.
Estimated tax: Individuals, including sole proprietors, partners and S corporation shareholders, generally have to make estimated tax payments if they expect to owe tax of $1,000 or more when their return is filed. Taxes are paid by either withholding them from a salary or through estimated taxes. If not enough is withheld or if there is other income such as capital gains, dividends, awards, etc., business owners may make estimated tax payments.
Self-employment tax: Self-employment tax is a social security and Medicare tax that helps provide self-employed individuals with retirement benefits, disability benefits, survivor benefits and hospital, or Medicare, benefits.
Employment taxes: Employers must pay employment taxes when they have employees working for them, which include social security and Medicare taxes, federal income tax withholding, and federal unemployment tax.
Excise tax: If a business owner manufactures or sells certain types of products, operates certain kinds of businesses, uses various types of equipment, facilities or products, or receives payment for certain services, there are different types of excise taxes and forms to file, explained in detail on the IRS website.
Additionally, here are a few things new business owners can keep in mind regarding the common types of business organizations.
Arguably the most common form of business ownership, a sole proprietorship is a type of company owned by a single individual. Entrepreneurs choose this option when they want to retain full control of the company. Sole proprietorships offer unlimited flexibility, are relatively easy and inexpensive to form, and there are few regulations involved; they often only require a business license to get started instead of excessive amounts of complicated paperwork. They also provide tax benefits to the owner, as income is considered the owner's personal income and, therefore, is only taxed once.
There are some downsides to a sole proprietorship. The owner is fully liable for any and all liabilities the company may incur. There are no distinctions between personal and business income, and equity is limited to the owner's own financial resources.
In a partnership, two or more individuals contribute money, property and skills to the business. They also share in the profits and losses, and both owners are responsible for the liabilities of the organization. There are three different types of partnerships:
General partnerships: Each individual participates in all business operations, and each has unlimited liability. In other words, each partner is responsible for the other's actions, and each partner's personal assets can be used to repay the debts of the partnership.
Limited partnerships: In this type of partnership, one general partner takes on unlimited liability for the organization and manages the company's operations. There may be limited partners in this partnership, and these partners only take on as much liability as their financial stake allows. These limited partners are not involved in management decisions and have no control over the company.
Limited liability partnerships (LLPs): Multiple partners are each responsible for the business's operations, but they are not responsible for the actions of the other partners or the debts of the company. Usually, LLPs are restricted to professions like accountants or attorneys.
There are some pros and cons to partnerships. For example, advantages like sharing resources can provide more shared total profits, and they are relatively inexpensive to form. However, each partner is responsible for all losses and debts, and ending a partnership and selling the business can be challenging.
A corporation can be more complicated to start up than other business types. Created by shareholders as a separate legal entity, incorporating a business protects owners from being personally liable for any legal disputes or debts against the company. In comparing an LLC or sole proprietorship versus a corporation, the main difference is that when an owner passes away or declares bankruptcy, the LLC or sole proprietorship would simply dissolve. A corporation, on the other hand, would continue to exist as a separate legal entity. According to the IRS, a corporation “conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders.”
Some of the benefits of creating a corporation include the fact that the profits and losses belong to the business, and that the owners have limited liability to debts and losses. Additionally, personal assets cannot be seized to pay for business debts. However, establishing and operating a corporation is costly.
C Corp vs. S Corp
A C corporation is the most common type of corporation. It is taxed as a business entity and owners receive profits that are taxed individually. An S corporation is another type of corporation and is similar to the C corp; however, it may only consist of up to 100 shareholders. An S corp is similar to a partnership, too, in that it avoids double taxation by allowing income or losses to be passed through on individual tax returns.
Limited Liability Companies (LLCs)
A limited liability company, or LLC, is a flexible type of business organization that combines aspects of both partnerships and corporations. In comparing an LLC versus a sole proprietorship or corporation, an LLC enjoys the tax benefits of a sole proprietorship and the limited liability of a corporation, as they exist as their own legal entity. An LLC is designed to be easier to start for a small business and is one of the most popular types for startups.
Each state has its own laws when it comes to owning a limited liability company, so entrepreneurs need to check their state's requirements and federal tax regulations for more information.
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