Business Entities

When starting a new business, small business owners need to consider the type of business entity to form.

There are unincorporated business entities like Sole Proprietorships, Partnerships and Limited Liability Companies (LLCs) and incorporated business entities like Corporations (C-Corp and S-Corp). Each business entity has its owns pros and cons including, but not limited to: complexity, formalities (ex: annual meetings), type of liability protection afforded, how the entities are treated for federal, state and local tax purposes and reporting requirements.

For instance, a Limited Liability Company (LLC) with a single member (aka Single-Member LLC) is treated by default as a disregarded entity for tax purposes and reports business income/expenses and profit/loss on their personal tax return typically on Schedule C (Form 1040). However, a Limited Liability Company (LLC) with two or more members by default will be taxed as a Partnership and at the entity level, would file a Partnership Return (Form 1065) at tax time with each member receiving a Schedule K-1 showing their pro-rata share of profit/loss from the business to be reported on their personal tax returns.

Limited Liability Companies (LLCs) may choose to change their default tax treatment and elect to be taxed as a corporation (typically electing to be taxed as a sub-chapter S or S-Corp by filing Forms 8832 and 2553). At the entity level, the LLC now taxed as a sub-chapter S or S-Corp would instead file a Corporation Income Tax Return (Form 1120) at tax time with each member receiving a Schedule K-1 showing their pro-rata share of profit/loss from the business to be reported on their personal tax returns.

Sole Proprietorships, Partnerships, Limited Liability Companies (LLCs) and S-Corps are typically treated as pass-through entities whereby income and the resulting taxes are passed down to and paid for at the member or shareholder level (personal tax return) rather than at the entity level thereby avoiding double taxation. Corporations (C-Corps) and Limited Liability Companies (LLCs) which elect to be taxed as C-Corps are taxed at the corporation level for any business profits and at the personal level for any distribution of profits to shareholders. Now that’s not to say there aren’t any entity level taxes even for pass-through entities. Each state and locality may have its own tax requirements at the entity level. For instance, New York S Corporations must file a New York S Corporation Franchise Tax Return and pay the appropriate Franchise Tax. In addition, New York City does not recognize the Federal or New York S election and as such, New York S Corporations in NYC are subject to the New York City General Corporation Tax and must file and pay accordingly.

When forming a new business entity, business owners should seek professional guidance from and consult with a CPA and legal counsel to be sure the best entity is selected for your particular business type and structure. Down the road, as your business grows and evolves, it may be a good idea to revisit the conversation with your CPA and legal counsel to see if there are any benefits to changing your entity classification.