Let’s be honest:
Starting your own small business from the ground up can be exciting.
This phenomenal idea you’ve had in mind for a while now has finally been transferred to paper.
You’ve shared your idea with a selected group of people who support you.
And you finally have a better understanding of domain names and which one would be suitable for your upcoming business.
The next part is selecting a business structure.
By choosing a business structure to solidify your business, a form of the business entity must be established. According to IRS, your type of business determines which income tax return form you have to file.
The most common forms of business structures are:
- Sole proprietorship
- Corporations (S and C)
- Limited Liability Company (LLC)
- Non Profit Businesses
Below are key points provided by revenue experts, who describe each business structure and will help you choose which one is best for your business!
A sole proprietorship is a small business structure in which “one person owns an unincorporated business by himself or herself,” according to the IRS. (Note: A sole business owner or sole member of an LLC, can not choose a sole proprietorship as their business structure.)
A partnership is a business structure in which one or more people come together to carry on a trade or business. Each person within the partnership contributes money, property, labor, or skill, and expects to share in profits and losses of the business.
Another form of partnership is a limited partnership. They typically are investors who give up management control for financial protection.
According to IRS, partnerships deal with income taxes in a manner very different from a corporation, for example. A partnership must file an annual information return to report the income, deductions, gains, losses, and the like, from its operations, but the company does not pay income tax itself. Instead, the partnership “passes through” profits or losses to its partners. As a result, each partner includes his or her share of the partnership’s income or loss on his or her personal tax return.
Limited Liability Company (LLC)
Limited Liability Company, also known as LLC, is the most common business structure among small businesses. An LLC is a business structure regulated by the state, so laws and practices vary from state to state. Owners of an LLC are referred to as members, and there is no maximum as to how many an LLC can have.
For tax purposes, an LLC can be treated in several ways by the IRS. For example, the IRS can classify your LLC as either a corporation, partnership, or as part of the LLC’s owner’s tax return, depending on elections made by the LLC and the number of members.
Corporations (S and C)
The S Corporation passes corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders of S Corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S Corporations to avoid double taxation on corporate income. S Corporations are responsible for tax on certain built-in gains and passive income at the entity level.
Other unique traits of S corporations include features such as limitations on who can be shareholders. Allowable shareholders include individuals, certain trusts, and estates. Non-allowable shareholders include partnerships, corporations, or non-resident alien shareholders. There can also be no more than 100 shareholders; only one class of stock and some corporations are ineligible to be S Corporations, such as certain financial institutions, insurance companies, and domestic international sales corporations.
C Corporations are recognized as separate taxpaying entities. A corporation conducts business, realizes net income or loss, pays taxes, and distributes profits to shareholders.
Another critical feature of C Corporations is how they are taxed. The profit of a corporation is taxed to the corporation when earned and then is taxed to the shareholders when distributed as dividends, creating a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any loss of the corporation.
Starting a nonprofit business is similar to starting a for-profit business, with business structures like LLCs and corporations being common. However, where LLCs are the most popular among startups, corporations are the more traditional business structure for nonprofits. Nonprofit corporations organize themselves like for-profit ones in terms of electing a board of directors and having bylaws. But a crucial difference is that, after filing their Articles of Incorporation, nonprofits then apply to the IRS for 501(c)(3) status, which recognizes them as tax-exempt organizations.
Starting a nonprofit LLC is certainly possible, but there are reasons why it is less common. State law regulates LLCs, and in many states, a crucial part of establishing an LLC is providing a lawful purpose or business purpose for the organization. It is providing a business purpose that can raise issues for creating a nonprofit LLCs in some states, which is why incorporating is still the traditional route.
If you decide on creating a nonprofit LLC, you’ll have to meet federal requirements to be considered a 501(c)(3) organization. In the case of an LLC, to be considered a 501(c)(3) organization, it must be owned by a sole member that is a 501(c)(3) or owned by two or more members that are all 501(c)(3) organizations.
After you have decided on the business structure that you feel is best for your business, be sure to research your state’s website to register your small business. You can also consider reaching out to BOND Small Business Group for guidance and assistance on how you may register your business.
Once you set up your business structure, you’ll need an affordable way to promote your new business. Join us today!