When starting a business, we recommend that everyone form an entity to operate the business. There are numerous considerations when choosing the specific type of entity for your business. One of the most significant considerations is determining how the entity and its owners will be taxed for Federal income tax purposes. 

Sole Proprietorship: A sole proprietorship is simply a person operating a business for profit in their name. The business and the person are one in the same. As such, for Federal income tax purposes, the sole proprietor is responsible for reporting and paying the taxes. 

Partnerships: Partnerships, whether they are general partnerships, limited partnerships, or some other variation, involve two or more partners operating a business and sharing profits and losses. For Federal income tax purposes, partnerships have specific tax treatment and rules under Subchapter K of the Internal Revenue Code. The partnership’s income, losses, deductions, and credits are passed through to the partners and reported to the IRS on their individual income tax returns with an IRS Schedule K-1. The partnership files an information return, known as IRS Form 1065, with the IRS, but is not actually responsible for any of the income taxes. 

Corporations: Corporations have two options for Federal income taxation—C Corporation or S Corporation. If taxed as a C Corporation, the corporation is a separate entity for tax purposes and it is responsible for its income, losses, deductions, and credits. The shareholders are only taxed on amounts of money or the value of property actually distributed to them by the corporation. The corporation will report and pay its taxes by filing IRS Form 1120 with the IRS. Alternatively, if the corporation qualifies as an S Corporation and makes the election to be taxed as such, the corporation’s income, losses, deductions, and credits are passed through to the shareholders and reported on their individual income tax returns with an IRS Schedule K-1. The corporation files IRS Form 1120-S with the IRS and related employment tax returns. While S Corporation taxation is similar to partnership taxation, it is not the same, with specific tax treatment and rules under Subchapter S of the Internal Revenue Code. 

Limited Liability Companies: Limited liability companies (LLCs) are one of, if not the, most popular business entity types partly because of the flexibility they offer in ownership, management, and taxation. As it relates to Federal income taxes, an LLC can be taxed as a sole proprietorship (also known as a disregarded entity), partnership, C corporation, or S corporation. 

Choosing the correct entity type for tax purposes is an important decision that can have long-term tax consequences for you and your business. At Starr Law Firm, P.C., we are well versed in the process of starting a business and forming a business entity, including, choice of entity for tax purposes. We will work closely with you and your accountant to help you make a decision that meets your particular needs.  Contact Starr Law Firm, P.C. to begin the process of forming a business today.