When starting a business, one of the most important things that you should know or evaluate is the types of forms you must file for your business.
Primarily, you’ll need to classify what type of business you have, whether Sole Proprietorship, Partnership or C corporation for the traditional corporation business, or the S Corporation for small businesses.
How do you know whether your business is a Sole Proprietorship, Partnership, C Corp or S Corp?
Let’s learn the similarities and differences between them.
Sole Proprietorship and Partnership
If you are willing to take personal responsibility for the success and failure of your company, you may pursue a sole proprietorship or partnership.
Why? Because both of them are appropriate for those who are interested in smaller, non-corporate business structures with fewer regulations. Compared to corporations, partnerships and sole proprietorships are relatively easy to form and are not responsible for corporate income taxes.
When it comes to personal liability, the owners of both sole proprietorships and partnerships are liable for debts and obligations. This includes the liabilities brought by employees or other partners. This means that in the possible case of being sued, the personal assets of both owners, like bank accounts and houses, may be subject to a plaintiff’s claim.
For taxation, owners of sole proprietorships and partnerships pay only personal income tax and not business income tax. This is because for business income, it is reported on the owner’s personal tax returns. For a partnership, owners are responsible for filing an annual partnership return with the IRS and the partnership itself does not pay taxes.
Instead, profits and losses are passed through the owners. Sole Proprietorships use Form 1040 while partnerships use 1065 (check out IRS’ Business Structures for different business forms).
In forming a business, both sole proprietorships and partnerships are relatively common business entities, as they are simple to set up and generally do not require registration with the business registrar. Both of these are formed as soon as the individuals begin doing business. Generally, these businesses may be set up without paying state filing fees that are associated with other business types, such as corporations.
When naming the business, to avoid additional registration, sole proprietorships and partnerships must operate under the names of its owners.
S corporation and C Corporation
S Corporations and C Corporations both share similarities:
- Both have limited liability protection so that owners are typically not personally responsible for business debts and liabilities.
- They are both separate legal entities created by state filing.
- They both file the Articles of Incorporation or Certificate of Incorporation.
- Both have shareholders, directors, and officers who direct corporate affairs and decision making.
- Both are required to follow the same internal and external corporate formalities and obligations.
In an S Corporation, the profits and losses are passed through the corporation onto you. In return, you can report the profits or losses on your income tax return. In an S corporation, the individuals will pay taxes on it’s profits and then the owners or shareholders will report money received from the corporation on income tax returns.
When it comes to taxation, C corps are separate taxable entities. They file corporate tax returns (Form 1120) and pay taxes at a corporate level. There are also some possibilities of double taxation once a corporate income is distributed to business owners, as dividends are considered personal income.
S Corps file an informational federal return (Form 1120S) but no income tax is paid at a corporate level. Any tax due is paid at the individual level by the owners.
We have just discussed the similarities and differences of common business structure forms between the four legal entities. Don’t hesitate to contact us for more questions and concerns.