When starting a business, choosing the right structure is important for various reasons, including taxes.
The structure you choose can significantly impact how much you pay in taxes and how you report your income.
Sole proprietorship
In February 2024, 436,358 individuals filed for business licenses in the U.S., many of which were sole proprietorships. In a sole proprietorship, one individual owns and operates the business. The IRS treats the business’s income as the owner’s personal income. Therefore, owners report business profits and losses on their personal tax returns using Schedule C of Form 1040. Since there is no legal distinction between the owner and the business, the tax process is relatively straightforward.
Partnership
A partnership involves two or more individuals who share ownership of the business. Each partner reports their share of the partnership income on their personal tax returns. Partnerships file an informational return (Form 1065) to report the business’s income, deductions, gains and losses.
Corporation
Corporations are separate legal entities. These entities pay taxes on their profits at the corporate tax rate. The government taxes shareholders on any dividends they receive from the corporation. This is often referred to as “double taxation” because the government taxes both corporate profits and shareholder dividend distributions.
Limited liability company
An LLC offers the limited liability protection of a corporation combined with the flexibility of a partnership or sole proprietorship. An LLC can choose its taxation. By default, the government taxes a single-member LLC a sole proprietorship and a multi-member LLC as a partnership. However, an LLC can also elect corporation taxation by filing Form 8832.
Before new business owners set up their corporate structures, they should weigh the advantages and disadvantages of the tax policies they could face.