This article covers the different options for registering your business with the Secretary of State’s office (in the state that you choose) and the tax implications of that business structure.  As stated in the Business Registration Overview article, there are three important considerations when considering business structure: 1) Number of owners and complexity of ownership, 2) liability of the potential venture and assets at risk, and 3) Tax Issues. 

Because this article only addresses business structure and the tax implications you may find it helpful to review the Business Registration Overview Article for a more complete list of the registration process.

There are four basic options when choosing your business structure with a single owner: General Partnership, Limited Liability Company, C-Corporation, and S-Corporation.  The following is an overview of the four different options.

1.      General Partnership

Liability - In a General Partnership the owners have unlimited liability for both the activities of the business and the activities of the other partners.  It is important to not that you are responsible for any debts, contracts, and other legal obligations that a partner agrees to on behalf of the company.  All owners are 100% responsible for the company’s activities and obligations individually and separately.  For any general partner there is no separation of business and personal assets.  In other words your personal property is not protected in the event that your company is facing litigation. 

Taxation – Each partner is taxed on their share of the income that the business produces.  Owners’ draws are not a deductible expense for tax purposes.  Taxable Income is determined by IRS form 1065 – Partnership Income, which is filed with each partner’s annual 1040 Individual Tax Return.  Taxable income is taxed on each partner’s personal tax level three different ways: Federal Income Tax, State Income Tax and Self Employment Tax.  Each partner should fill out IRS form 1040-ES to determine their own estimated quarterly withholding payments to the IRS.

Self Employment Tax is a payment that funds Social Security Insurance and Medicaid.  In a normal employment situation you would pay half the amount due and your employer would match the same amount.  Since you are self-employed you will have to pay both halves which amounts to 15.3% of your total net income up to $94,200.  Income above and beyond that amount is only taxed at 2.9% for Medicare which has no upper limit.  Self Employment taxes for each partner are filed at the end of the year using IRS form 1040-SE.

Registration – Because of the liability issues of a partnership it is advisable to create a Partnership Agreement that spells out the legal obligations, rules and expectations of each partner.  A formal agreement will help avoid any potential for conflict between partners and serve as legal documentation if the event that a breach of the agreement occurs.

Like a sole proprietorships there is no business registration required for partnerships.  If partners start a business using their own names, has no employees and only sells services the only requirement is that each partner file their income taxes with the state and federal government.

If you choose to use a name other than your own you will need to file a Partnership Fictitious Name Certificate with the Secretary of State.

2.      Limited Liability Company

Liability – Limited Liability Companies provide limited liability protection to all owners for the activities of the business.  This means that there is a separation of your business and personal assets and your business is an entity in the eyes of the law.  Your personal assets are protected in the event that your company is facing litigation. 

Limited Liability Companies do not issue stock.  Ownership is divided amongst the owners through an operating agreement.  An operating agreement is a formal document signed by the owners spelling out the percentage of ownership, responsibilities in the company, survivorship, transfer of ownership and other company issues.  Because an LLC does not issue stock current owners must sell ownership with the addition of new owners.

Taxation – Limited Liability Companies are not recognized by the IRS for tax purposes (they are considered a “disregarded entity”) therefore you can elect how you would like your business to be taxed.  By default, a multi member LLC is taxed like a general partnership as described above.  Companies can also elect to be taxed like a corporation, as described below, by filing IRS form 8832.  Finally, if a company elects to be taxed like a corporation they can make a second election to receive Subchapter-S status as described in section four.

Registration – Registering an LLC requires that you file Articles of Organization with the Secretary of State.  Most states provide a sample format that you can follow stating the business name, ownership, length of existence, and other articles of organization.  Also, most states require that a company have on file a Registered Agent.  In most states Limited Liability Companies have a maximum number of owners.

A registered agent is a person or company that will accept correspondence on behalf of the company typically in the event of litigation.  If you live in the state you are registered in you can serve as your companies registered agent.  If not, a local attorney or a company that provides registered agent services can be retained for a small fee.  A registered agent must have a physical address in the state in which the company is registered.

3.      C-Corporation

Liability – Like an LLC a single owner C-Corporation is given limited liability protection for the activities of the business.  This means that all current and future shareholders personal assets are protected in the event that your company is facing litigation. 

Corporations issue stocks to their owners in exchange for investment in the company.  Shareholders are not liable for any of the companies’ actions or obligations and their losses are limited to their initial investment in the company.  Companies can issue an unlimited number of additional company stock at any time diluting the value of current stockholders through a vote by the board of directors.

Taxation – Taxable income is determined by IRS form 1120 and your estimated quarterly payments by filling out IRS form 1120-W.  C-Corporations are subject to double taxation.  The business is taxed on the net income the business produces on a state and federal level and it is taxed again on the dividends the company pays to its shareholders at a rate of 15%.  Owners who work in the business can deduct their salaries as a business expense but this pay is treated as a normal employee paycheck (State, Federal, and both halves of Social Security & Medicare). 

Registration – Registration and maintenance of a Corporation is a complex and time consuming process.  You will be required to file Articles of Incorporation with the Secretary of State.  A board of directors will have to be formed and an annual report will have to be filed in order to stay in good standing with the state you are registered.  Most states provide a sample format that you can follow stating the business name, authorization of stock, length of existence, and other articles of organization.  Also, most states require that a company have on file a Registered Agent. 

4.      S-Corporation

An S-Corporation is essentially a C-Corporation that has elected Subchapter-S status by filing IRS form 2553.  This tax election allows a corporation to avoid double taxation by way of a dividend pass-through feature for the shareholders of the company.  Like a C-Corporation owners can deduct a salary, but all of the taxable income the company produces is automatically paid out to the owners and is not subject to the normal 15% dividend tax.  The number of owners that can participate in a S-Corporation is limited by the IRS to 75 members and owners must be individuals (companies are exempt from ownership) among other limitations.

Small Business Corporations file their business taxes using form 1120S.  It is important to remember however, S-Corporations are a passthrough entity and therefore do not pay taxes at the corporate level but rather the individual shareholders pay taxes based on their percent ownership.