When starting a business you will have choices as to how you will conduct your business. The short summaries that follow are not the only choices, but are the most common.
Sole Proprietorship
A sole proprietorship is owned by a single individual and does not require incorporation. This form will not be taxed separately from the owner. All income will be taxed to the sole owner. This form can either be in the name of the owner or under a business name. This is the simplest of the choices. The main disadvantage of the sole proprietorship is the unlimited liability to the owner.
Partnership
This is a business with more than one owner and can be in existence without a written agreement. The partnership can have significant tax benefits to the owners. The disadvantage is that the partnership is not a liability shield for the owners and each of the owners is responsible for debts incurred by any of the other partners.
Limited Partnership
The limited partnership must have at least two persons, one of which is the general partner. The liability of the general partner is unlimited and the limited partners will only be liable up to the amount of their contribution. Generally, the management of the company is left to the general partner and the limited partners will not be active. The advantages are the ability to avoid double taxation, tax free formation, the ability to specifically allocate items of income and deduction, the inclusion of both capital contributed and a share of the entity’s debt in the partner’s basis and permitting contributions of property where liabilities assumed by the partnership in excess of the partner’s basis are not automatically considered taxable income. Disadvantages include unlimited liability to the general partners, required use of calendar tax year, fringe benefits will be taxed as income and partner’s earnings are subject to FICA.
Limited Liability Company (LLC)
This is an excellent chameleon entity. You can elect to be sole proprietorship, partnership, C corporation or S corporation for income tax purposes by filing a form. The LLC is a separate entity with limited liability required to file Articles of Organization with the Arizona Corporation Commission. Professional LLC’s can be formed as can Limited Liability Partnerships and Limited Liability Limited Partnerships. A potential disadvantage is the fact that not all states are uniform in the way they treat LLC’s.
C Corporation
A corporation will be created when Articles of Incorporation are filed with the Arizona Corporation Commission. The corporation has limited liability, centralized management, free transferability of interests and continuity of existence. The C corporation is taxed as a separate entity and the dividends or distributions are taxed as income to the recipients. The advantages include: election of fiscal year, dividends received may be deducted in full, may deduct their passive activity losses in full, corporations and shareholders can participate in a broad range of fringe benefits which can be deducted by the corporation and a C corporation can have more than one class of stock.
S Corporation
An S corporation is a regular corporation that elects to have the corporation’s profits and losses pass through the corporation to become taxed at the individual shareholder’s tax level with some conditions. The S corporation can only have individuals as shareholders (not corporations), can have no foreign ownership, can only have one class of stock, must use a calendar year and has a limit on the number of shareholders.