Types of Business Entities Once you have made the decision to start a business, the next question is what type of entity to form. There are 3 main types of business entities: Sole Proprietorship Partnerships Corporations Each type of entity has advantages and disadvantages. It is important to meet with your tax advisor before setting up any type of entity. The tax benefits vary greatly between the types of entities. Sole proprietorship The sole proprietorship is the least complicated to form and the easiest to operate. The business is operated by a single person. The owner is not considered an employee. However a spouse that works in the business can be an employee. The owner and the business are considered one entity for tax purposes. All business net earnings are subject to self-employment taxes. Business income is reported on the individuals’ Form 1040, Schedule C. Sole proprietors are liable for the debts of the business and may be subject to unlimited liability. Partnerships General Partnership A General Partnership is any business operated by two or more people with the understanding there shall be proportional sharing of profits and losses between them. Partners are not considered employees of the company. All business income is reported on a 1065 Partnership return. The partnership is not required to pay taxes. Each partner is given a K-1 with their share of income or losses. This “flows through to the partner’s individual personal tax return. Each partner is responsible for paying their share of personal income tax. Partnerships should have an operating agreement for the partners. Some states require registration with the Secretary of State. Partners are liable for the debts of the business and may be subject to unlimited liability. Limited Partnership A limited partnership is made up of one or more general partners and one or more limited partners. A general partner can participate in the management of the business and is personally liable for the debt of the business. A limited partner is not personally liable for debts of the partnership. A limited partner can not participate in the management of the partnership or they become a general partner. Corporations S Corporation An S Corporation is considered a separate entity from the individuals who operate it. A corporation issues shares of stock to show ownership. A corporation files its own tax return. The corporation doesn’t pay tax on the form 1120S. S-corps are also “flow through” entities. Each shareholder is given a K-1 with their share of income and losses to report on their individual income tax returns. Some states do require some tax at the corporate level. Check with your tax advisor or Secretary of State. Shareholders that provide services or manage the business are considered employees. The corporation has its own name and identity, and all business assets and liabilities belong to the corporation. An advantage of incorporating is that it limits personal liability and protects your personal assets. C Corporation C Corporations are the most complex business entities. The Corporation is a separate entity. All business assets and liabilities belong to the corporation this creates a limited liability for the shareholders. The corporation must pay its own tax on the income earned in a corporation. If income is distributed to shareholders it is considered dividends. Shareholders must pay tax on what they receive as dividends, creating “double taxation”.