Key options for structuring business in USA include: Sole Proprietorship, Partnerships (General Partnership and Limited Liability Partnership) , Corporations (S Corp & C Corp) and Limited Liability Corporations. There are tradeoffs and tax impacts to be considered while choosing a specific structure or changing the same with evolving need.
Sole Proprietorship
A sole proprietorship is the simplest form of business structure and is not a separate legal entity. The owner makes all decisions, and all profits and losses belong to this person and are recorded as part of their income in their income tax return. The business itself is not taxed.
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Permits and Licenses: May be necessary where state or local law requires them for specific types of business (e.g., liquor licenses for restaurants).
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Federal Employer Identification Number (EIN): Required if the business employs people.
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Personal Liability: The owner is personally liable for the business’s obligations.
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Tax Reporting: Income is reported using Form 1040 and Schedule C (Profit & Loss from sole proprietorship business). Other key IRS forms include Schedule SE (Self-Employment Tax), Form 941 (Quarterly Return for Social Security and Medicare taxes), Form W-2 (Wages and Tax Statement), and Form 940 (Annual Return for Federal Unemployment Tax). A sole proprietor pays self-employment tax of 15.3% on all profits.
Partnerships
A partnership is formed when two or more persons agree to do business together. It can be formed informally by oral agreement or formally by a written partnership agreement.
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Types of Partnerships:
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General Partnership: All partners have equal rights to manage the partnership and share equally in profits and losses. Partners have unlimited personal liability for the partnership’s debts.
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Limited Liability Partnership (LLP): Offers limited liability protection and is often used by professionals such as attorneys and accountants. Requires state filing and a registered agent.
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Tax Reporting: Profits and losses flow through to the partners and are reported using Form 1065 (K-1 Schedule) and Form 1040 (with Schedule SE for self-employment tax).
Corporations
There are two types of corporations: S Corporations and C Corporations.
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S Corporations:
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Formation: Must submit Form 2553 (Election by a Small Business Corporation) signed by all shareholders.
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Tax Features: Pass-through structure for tax purposes, with restrictions on the number of shareholders (max 100) and no non-resident alien shareholders.
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Tax Reporting: Files Form 1120S and Schedule K-1 for shareholders’ profits, reported in their tax returns via Form 1040.
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C Corporations:
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Formation: No restrictions on the number of shareholders or non-resident alien shareholders.
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Tax Features: Not a pass-through structure; profits are taxed at the corporate level and again as dividends to shareholders (double taxation).
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Tax Reporting: Files Form 1120 as an entity.
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Limited Liability Company (LLC)
An LLC is a business structure allowed by state statute and offers characteristics of both partnerships and corporations.
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Formation: Formed by filing articles of organization with the state. Most provisions regulating the LLC are contained in an operating agreement.
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Taxation: IRS treats LLCs as either a corporation, partnership, or part of the owner’s tax return (a disregarded entity) based on elections made via Form 8832.
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Self-Employment Tax: Distributions attract self-employment tax of 15.3% on all profits if not elected as a corporation.
Depending on elections for IRS taxation (via Form 8832 Entity Classification Election) made by the LLC and the number of members, the IRS will treat an LLC as either a corporation, partnership, or as part of the LLC’s owner’s tax return (a “disregarded entity”). Distributions in case there is no election as Corp will attract self-employment tax of 15.3% (Social Security and Medicare) on all profits.
A limited liability company that transacts business in states outside of its state of organization will have to apply for authority to do business in those foreign states. The LLC laws provide that the laws of the state in which a foreign LLC was organized will govern its internal affairs and the liability of its members.
For more information refer the IRS website:
