Types of Business - Legal Structures
A sole proprietorship is an unincorporated business that is owned by one individual. It is the simplest form of business organization to start and maintain, it has no separate existence from the owner. Its liabilities are the owner’s personal liabilities. All assets of the business whether used in the business or personally owned are at risk. The income and expenses of the business are included on the individual owner’s own tax return.
A partnership is the affiliation between two or more persons who join to carry on a trade or business together. Each person contributes money, property, labor or skill, and shares in the profits and losses of the business.
A partnership must file an annual information return to report the income, deductions, gains, losses etc., from its operations, but it does not pay income tax directly. Any profits or losses are "passed through" to its partners. Each partner includes his or her share of the partnership's income or loss on his or her tax return.
Partners are not employees and should not be issued a Form W-2. The partnership must furnish copies of Schedule K-1 (Form 1065) to the partners by the date Form 1065 is required to be filed, including extensions.
When forming a corporation, prospective shareholders exchange money, property, or both, for the corporation's capital stock. The profit of a corporation is taxed to the corporation when earned, then distributed as dividends to the shareholders when it is taxed as personal income. Shareholders cannot deduct any loss of the corporation on their individual returns.
An eligible domestic corporation can avoid double taxation (first to the corporation and again to the shareholders) by electing to be treated as an S corporation. Generally, an S corporation is exempt from federal income tax other than tax on certain capital gains and passive income. On their tax returns, the S corporation's shareholders include their share of the corporation's separately stated items (income, deduction, loss, and credit,) and their share of non-separately stated income or loss.
Limited Liability Companies
A Limited Liability Company (LLC) is a relatively new business structure allowed by state statute.
LLCs are similar to a corporation in that owners have limited personal liability for the debts and actions of the LLC. Other features of LLCs are more like a partnership, providing management flexibility and the benefit of pass-through taxation.
Owners of an LLC are called members. Since most states do not restrict ownership, members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Most states also permit "single member" LLCs, those having only one owner.