Tax Implications of Different Business Structures

Note: This is not legal or financial advice, and I am not an attorney or an accountant. This is just the notes of someone trying to figure out their new business and its taxes.

• Every business has two types: a Tax Type and a Legal Type
  • Tax Type is determined by their Legal Type
• Legal businesses are formed with State Law (not Federal Law)
  • Businesses file within the states they operate in, making who owns the business public
  • Businesses will be listed online with state government as “In Good Standing” or not
  • Every business is required to be able to receive correspondence
  • General rule is that to form a business you have to file paperwork with the state
• Businesses must maintain a separate business:
  • Keep business accounting records
  • Separate business bank account and use it
  • No co-mingling of funds (no personal expenses from business and vice versa)
  • This protects the business owners' assets and future earnings from having to pay someone if something goes wrong

5 Business Tax Types and their Tax Return

1. Self-Employed Business - on Schedule C (attached to owner’s Form 1040)
2. Partnership (“P-Ship”) - Form 1065 with attached Schedule K-1

• Owners then use info on Schedule K-1 on their own Form 1040

3. Corporation (C-Corp) - Form 1120

• Various forms filed for each employee (and owner) so employees get a W-2

4. S-Corporation (S-Corp) - Form 1120-S

• Combines aspects of partnership and corporation
• Includes Schedule K-1s attached to 1120-S
• Owners use info on Schedule K-1 on their own Form 1040

5. Charitable Organization - Form 990

7 Most Common Legal Business Types

1. Sole Proprietor - created automatically by operating

• No specific form needs to be filed, but may need to register with the state
• No separate from the owner, business and owner are the same
• Taxed as Self-Employed taxpayer

2. Partnership - formed legally when people work together with the intention to share in profits or losses

• Nothing needs to be put in writing, can just start
• Can be formed formally through the state (ex: LLP)
  • Whether they have liability depends on the specific state
• Most people don’t use a partnership anymore, instead using MMLLC
• Taxed as a Partnership
• Business must file before the partners can file their personal returns

3. Married Couple Owning a Business Together - “Qualified Joint Venture” - election for married couples who don’t want to file a P-Ship

• File as self-employed with two schedule Cs

4. Corporation - taxed as a Corporation

• Hundreds of years old

5. Single-Member LLC (SMLLC)

• LLCs were formed because many people were forming corporations but those corporations weren’t holding up in court - became popular across many states over the past 20 or 30 years
• Provides limited liability protection for owners, but requires fewer moving parts than the corporation
• Intended for small business
• No separate tax form - how they are taxed depends on how many members of the LLC there are
• Default for SMLLC: taxed as Self-Employed with a single Schedule C
• Best of both worlds: limited liability, but able to take self-employed tax write-offs

6. Multi-Member LLC (MMLLC)

• 2 or more members
• Default for MMLLC: taxed as Partnership

7. “Non-Profit” Charitable Organization

• Structured similarly to a corporation
• No shareholders, just donors

Other

• S-Corp - S-corp is a tax only type of business
  • Can be elected by SMLLC, MMLLC, P-Ship, C-Corp
  • Must meet the criteria for an S-corp to elect this option
  • Generally for a smaller business, but generally doesn’t save money for self-employed businesses where the owner works in the business
  • With the latest new development in business taxes (20% deduction for next five years), S-Corp is not recommended
  • Note: C-corp can also be elected by LLCs and P-Ship