Our firm has a strong focus on Small Businesses. Our experience comes both from education and experience. We are small business owners and so we would not suggest something for you that we would not do ourselves.

One of the most common questions that our office receives is what type of business set-up is right for me? To answer that question for anyone we need to first explain the possibilities:

Legal Definition
Tax Definition

Limited Liability Corporation
Corporation
Limited Liability Partnership
Partnership
Corporation (C, S or B)
Sole Proprietor
Partnership
Sole Proprietor

For tax purposes 99.99% of businesses will fit into one of these three tax classifications. An LLC is considered a disregarded entity and so an LLC will elect to be treated as one of the tax classifications for tax purposes. Each classification has its own advantages and disadvantages, below you will find a brief breakdown of each. If you would like to get more advice please feel free to contact us and we would be happy to help at no charge.

Sole Proprietor – Legal Definition

A sole proprietorship is the simplest and most common structure chosen to start a business. It is an unincorporated business owned and run by one individual with no distinction between the business and you, the owner. You are entitled to all profits and are responsible for all your business’s debts, losses and liabilities.

Forming a Sole Proprietorship

You do not have to take any formal action to form a sole proprietorship. As long as you are the only owner, this status automatically comes from your business activities. In fact, you may already own one without knowing it. If you are a freelance writer, for example, you are a sole proprietor. But like all businesses, you need to obtain the necessary licenses and permits. Regulations vary by industry, state and locality. Consult with a professional to determine what filings are required. If you choose to operate under a name different than your own, you will most likely have to file a fictitious name (also known as an assumed name, trade name, or DBA name, short for “doing business as”). You must choose an original name; it cannot already be claimed by another business. If you are forming your company in the state of Utah you can use the Department of Commerce website to determine if your name has already been claimed.

Sole Proprietor Taxes

Because you and your business are one and the same, the business itself is not taxed separately-the sole proprietorship income is your income. You report income and/or losses and expenses on the standard Form 1040. The “bottom-line amount” from Schedule C transfers to your personal tax return. The net income of the business is taxed at ~15% to cover Social Security and Medicare taxes and then the remaining income is taxed at your personal effective tax rate. You can find more information about sole proprietorship taxes at IRS.gov.

S Corporation

An S corporation (sometimes referred to as an S Corp) is a special type of corporation created through an IRS tax election. An eligible domestic corporation can avoid double taxation (once to the corporation and again to the shareholders) by electing to be treated as an S corporation. An S corp is a corporation with the Subchapter S designation from the IRS. To be considered an S corp, you must first charter a business as a corporation in the state where it is headquartered. According to the IRS, S corporations are “considered by law to be a unique entity, separate and apart from those who own it.” This limits the financial liability for which you (the owner, or “shareholder”) are responsible. Nevertheless, liability protection is limited – S corps do not necessarily shield you from all litigation such as an employee’s tort actions as a result of a workplace incident. What makes the S corp different from a traditional corporation (C corp) is that profits and losses can pass through to the your personal tax return. Consequently, the business is not taxed itself. Only the shareholders are taxed. There is an important caveat, however: any shareholder who works for the company must pay him or herself “reasonable compensation.” Basically, the shareholder must be paid fair market value, or the IRS might reclassify any additional corporate earnings as “wages.”

Combining the Benefits of an LLC with an S Corp

There is always the possibility of requesting S Corp status for your LLC. Your attorney can advise you on the pros and cons. You’ll have to make a special election with the IRS to have the LLC taxed as an S corp using Form 2553. And you must file it before the first two months and fifteen days of the beginning of the tax year in which the election is to take effect.
The LLC remains a limited liability company from a legal standpoint, but for tax purposes it’s treated as an S corp. Be sure to contact us if you are considering forming an S Corp to learn about tax requirements and benefits.

Partnership

A partnership is a single business where two or more people share ownership.

Each partner contributes to all aspects of the business, including money, property, labor or skill. In return, each partner shares in the profits and losses of the business.

Because partnerships entail more than one person in the decision-making process, it’s important to discuss a wide variety of issues up front and develop a legal partnership agreement. This agreement should document how future business decisions will be made, including how the partners will divide profits, resolve disputes, change ownership (bring in new partners or buy out current partners) and how to dissolve the partnership. Although partnership agreements are not legally required, they are strongly recommended and it is considered extremely risky to operate without one.

Types of Partnerships

There are three general types of partnership arrangements:

General Partnerships assume that profits, liability and management duties are divided equally among partners. If you opt for an unequal distribution, the percentages assigned to each partner must be documented in the partnership agreement.

Limited Partnerships (also known as a partnership with limited liability) are more complex than general partnerships. Limited partnerships allow partners to have limited liability as well as limited input with management decisions. These limits depend on the extent of each partner’s investment percentage. Limited partnerships are attractive to investors of short-term projects.

Joint Ventures act as general partnership, but for only a limited period of time or for a single project. Partners in a joint venture can be recognized as an ongoing partnership if they continue the venture, but they must file as such.

Forming a Partnership

You’ll also need to establish your business name. For partnerships, your legal name is the name given in your partnership agreement or the last names of the partners. If you choose to operate under a name different than the officially registered name, you will most likely have to file a fictitious name (also known as an assumed name, trade name, or DBA name, short for “doing business as”).

The registration process can involve many steps at both the federal and state levels, we would encourage you to contact a professional for assistance.

Partnership Taxes

A partnership must file an “annual information return” to report the income, deductions, gains and losses from the business’s operations, but the business itself does not pay income tax. Instead, the business “passes through” any profits or losses to its partners. Partners include their respective share of the partnership’s income or loss on their personal tax returns.

Partnership taxes generally include:

  • Annual Return of Income
  • Employment Taxes
  • Excise Taxes
  • Partners in the partnership are responsible for several additional taxes, including:
  • Income Tax
  • Self-Employment Tax
  • Estimated Tax

Employees

Hiring employees can be one of the biggest liabilities of any business. If you start to pay even one employee there are an additional ~15 tax filing requirements throughout the year. Often times this motivates employers to try to use “independent contractors” which in many cases can end up costing the employer more than employees. Please consult our payroll page for additional information.

If you are hiring employees, read more about federal and state regulations for employers.