When starting a home based business, setting up the form of your business is very important. It determines how you’ll be taxed as well as the personal liability and administrative work involved.
There are five common business legal structure types; Corporation, sole proprietorship, partnership, S corporation, and limited liability company (LLC) or limited liability partnership (LLP). Each one has different tax implications so it’s important to work with an accountant or tax attorney when making this decision:
The corporation is more complicated than many of the other business organizations. It’s an independent legal entity separate from the owners. Because of this the regulatory and tax requirements are more complicated. Because each state has its own regulations with regard to corporations, the rules and regulations are more complicated so you really need and attorney for guidance.
The benefit of the corporation structure is the protection from liability it provides its owner(s). Probably the best example of this is the debts of a corporation. They are not considered the responsibility of the owner. The owners assets are not at risk with a corporation.
Corporations can sell shares of stock in the company to raise money. And these shares can be bought and sold regardless of the ownership of the company. With regard to taxes the owners pay double the tax – taxes on the corporate earnings as well as taxes on the income they make from the company as dividends. The corporation structure is not typically used when starting a home based business as there are better options.
This is the simplest business organizational structure when starting a home based business. This typically involves an individually owned business and may be beneficial if you are the sole owner – or sole proprietor. Sole proprietor businesses are frequently self funded as many banks are reluctant to lend to these types of arrangements.
Unlike the corporation structure, the income you make from a sole proprietorship is only taxed once. However you are entirely responsible for any of your businesses liabilities – these cannot be separated from the owner under this arrangement. So your assets may be at risk as a result of legal action against the company.
Taxes for the sole proprietor structure are simpler as the expenses and income are included in your personal income tax return – Schedule C. The benefit is that your losses will directly offset your income.
Sole proprietors have to also pay self employment taxes using the Schedule SE with the 1040 income tax return. You may also have to make periodic estimated tax payments.
Partnerships are best suited when there are more than one stakeholder or owner when starting a home based business.
There are two types of partnerships; limited and general. General partnerships the owners operate the business and are responsible for the its debts. A limited partnership has both general and limited partners. The general partners own and operate the business while the limited partners are only investors with not operational control.
Its a good idea to have partnership agreements for this arrangement. This would detail how decisions are made, buyout terms, dispute resolution, etc. If things go wrong between the partners, you’ll be glad you had an agreement. The time to make these arrangements is at the wedding – not the divorce!
General partners in this arrangement are liable for the business debts. All of the partners in this structure can act on behalf of the business. However if a partner takes on debts or obligations, all the partners are bound to these obligations.
Partnerships are have tax advantages. The income and loses of the business pass through to the partners. These income or loses are reported to the IRS via Form 1065. Each individual reports their income or loss on schedule K-1 of Form 1065.
Setting up this type of business arrangement should be done with the help of good legal and accounting counsel.
S corporations may have up to 100 shareholders which is a more attractive business structure to investors. The disadvantage to the S Corp is the corporate rules they must follow. This makes the tax and legal issues more complicated. The costs to set up this arrangement can be similar to the conventional corporate structure do to the additional regulations.
S corporations do provide the owners with liability protection while also providing tax benefits. The income is only taxed once as it’s passed through on the owners personal tax return. So you’re not subject to double taxation as with some other arrangements.
Limited Liability Company (LLC)
LLC’s have recently become more popular with entrepreneurs as they include the best features of corporations and partnerships. They provide the protection from liability of a corporation without the double taxation of the corporation. Income and losses pass through to the owner on their personal income tax returns.
The LLC is very similar to the S corporation but with no shareholder limitations. Owners or members of the LLC can be involved in the operation of the company.
Non profits are created to provide a benefit to the public. They are established under the laws of the particular state where they operate. With the non-profit arrangement, the profits made by the organization go back into it – the opposite of for profits where the profits are distributed to the owners and shareholders. This form is not very common when starting a home based business.
Non profits are not necessarily exempt from federal taxes. The organization must make an application to the IRS to be considered tax exempt. There are certain things a tax exempt organization cannot do.
Navigating all the requirements of a non profit arrangements should be done with the help of a qualified and experienced legal counsel. This type of business structure is not typically seen for home businesses.
Consult A Professional
Consult with an accountant or tax attorney for guidance when starting a home based business. This isn’t a real complicated for them as they do it all the time. However what you spend on a professional can pay for itself quickly as we learned.
When we established our medical billing company we tried to do it ourselves. We ended up having to pay a lot more in taxes than we would have otherwise. If we had just spent a little time and money for the services of a professional, it would have really saved us. The money we did spend on accounting services and advice paid for itself many time over.