The most common forms of business are the sole proprietorship, partnership, and corporation. When beginning a business, you must decide which form of business to use. Legal and tax considerations enter into this decision. Tip. Your form of business determines which income tax return form you have to file.
Sole proprietorships (Schedule C). A sole proprietorship is an unincorporated business that is owned by one individual. It is the simplest form of business organization to start and maintain. The business has no existence apart from you, the owner. Its liabilities are your personal liabilities and you undertake the risks of the business for all assets owned, whether or not used in the business. You include the income and expenses of the business on your own tax return.
More information. For more information on sole proprietorships, see Publication 334, Tax Guide for Small Business. But if you are a farmer, see Publication 225, Farmer's Tax Guide.
Partnerships (Form 1065). A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor, or skill, and expects to share in the profits and losses of the business.
A partnership must file an annual information return (Schedule K-1) to report the income, deductions, gains, losses, etc., from its operations, but it does not pay income tax. Instead, it "passes through" any profits or losses to its partners. Each partner includes his or her share of the partnership's items on his or her tax return.
More information. For more information on partnerships, see Publication 541, Partnerships.
Corporations (Form 1120). In forming a corporation, prospective shareholders transfer money, property, or both, for the corporation's capital stock. A corporation generally takes the same deductions as a sole proprietorship to figure its taxable income. A corporation can also take special deductions.
The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. However, shareholders cannot deduct any loss of the corporation.
More information. For more information on corporations, see Publication 542, Corporations.
S corporations (Form 1120S). 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 corporation generally is exempt from federal income tax other than tax on certain capital gains and passive income. Its shareholders include on their tax returns their share of the corporation's separately stated items of income, deduction, loss, and credit, and their share of non-separately stated income or loss.
More information. For more information on S corporations, see the instructions for Form 2553, Election by a Small Business Corporation, and Form 1120S, U.S. Income Tax Return for an S Corporation.
Limited Liability Company. A limited liability company (LLC) is an entity formed under state law by filing articles of organization as an LLC. None of the members of an LLC are personally liable for its debts. An LLC may be classified for federal income tax purposes as either a partnership, a corporation, or an entity disregarded as an entity separate from its owner by applying the rules in regulations section 301.7701-3. See the instructions for Form 8832, Entity Classification Election, for more details.