Most business owners start out as a Sole Proprietor. It is the easiest entity to work within. It is for single-owner businesses. The business does not have to be registered each year, and more importantly, it does not need a separate tax return filed each year. Business activity is simply reported on a Schedule C as part of the individual?s personal income tax return (1040).
It is important to know that at tax time, the individual will owe income tax on the net profit from their business. In addition, they will also owe what is commonly referred to as self-employment-tax. This is comprised of 12.4% (of net profit) due in for Social Security and 2.9% for Medicare. This seems very high, and it is high because as a business owner, you are not only required to pay in 7.65% of your earnings, but match them as your own employer. Again, keep in mind that this is above and beyond the income tax that is due.
An LLC is a business structure that is formed to limit the liability of the member(s) who own the business. The business can file taxes as a sole proprietor, partnership or corporation. However, there are limited opportunities / time frames in which the election must be made to be treated as a corporation and a filing is required with the IRS. An LLC can have a foreign partner, but an S Corp cannot. These entities are great for someone purchasing rental property to allow for asset protection and isolate that property. This entity may or may not need an additional tax return depending on the number of partners and the elections made which would be an additional fee. It is also required to be renewed with the state each year for a fee.
An S Corporation is a corporation that makes an S Election which is a special designation with the IRS. This entity must file it?s own tax return (1120S), but does not pay it?s own taxes. Instead, the profit or loss from the corporation is passed on to the shareholders and reported on their own individual tax returns via a K-1 form issued by the corp. This entity allows the business to pay out only a portion of the profit as salary, the amount determined by what is ?reasonable compensation?. This amount is subject to the roughly 15% of self-employment / payroll tax eluded to in the paragraph above, and the remainder of the income flows thru in the form of investment income on the K-1 only subject to income tax. The corporation needs it?s own tax return which is an additional fee. There are fees for payroll, whether using a bookkeeper or payroll company, and this entity also has to be renewed with the state every year for a fee.
To summarize above, there are instances in which each of the above
entities are best and this is governed by individual circumstances of the
business. Hamilton and Phillips can help you to figure out
the best entity for your business. We also form LLCs, Corporations, Partnerships, etc... We look forward to helping you.