In order to do business, a business owner must create a legal entity that represents the firm. There is no magical entity that works for everyone. There are multiple options, each with different implications on liability, taxation and how you choose to be paid.
The sole proprietorship is the easiest and least expensive form of ownership. The owner reports income or loss on Internal Revenue Service Form 1040 Schedule C and pays self-employment tax on all income. The business owner is responsible for all business debts and has unlimited liability. It is recommended that the owner register an assumed business name with the Idaho Secretary of State.
This is very similar to the sole proprietorship. It is strongly suggested that the partners develop a written partnership agreement that spells out each partner’s share of the ownership, how profits and expenses are split, operational expectations and how the business will be dissolved under any and all circumstances. The partners are liable for all business debt and report their share of the profits on their personal tax returns.
Limited partnerships usually are formed for real estate and other investment programs. The structure is similar to a general partnership except the limited partners have no liability for business debt, providing they do not participate in management of the partnership. There must be a partnership agreement; the partnership must file with the Secretary of State’s office; and an annual report and renewal fee must be provided to the Secretary of State. The partners report their shares of the profits on their personal tax returns.
Limited Liability Company
The LLC is the most common legal structure for a small business. The primary benefit is that the owners have limited personal liability. Forming this type of entity requires preparation of an operating agreement that describes how the business will be operated, including payment of expenses and division of profits. Articles of organization must be filed with the Secretary of State. An annual report and a maintenance fee also must be submitted. There are few restrictions on how profits are allocated to members. Profits would be reported on personal tax forms, but in some cases the LLC can elect to be taxed as a corporation.
C corporations are able to raise capital by the sale of stock. Shareholders have limited liability exposure. Profits can be split between the shareholders and the corporation, and both shareholders and the corporation pay taxes on profits. Requirements include articles of incorporation, bylaws, annual shareholder meetings, corporate resolutions, and minutes from shareholder and board meetings.
The principle difference between a C-corp and an S-corp is the way taxes are handled. In the S-corp, the company’s profits are passed through to the owners. Corporate formalities are about the same as for C-corps. S-corps cannot have foreign shareholders.