Do you have unanswered questions about forming a business? This big picture explanation, WILL help!
To form a business, you can do either:
- Form A Separate Business Entity With The State:
- Why do owners do this? Limited Liability for the Owners personal property.
- What are the types of businesses? Corporation, General Partnership, Limited Liability Partnership, Limited Liability Company (LLC)
- Begin selling products or providing services, with no separate entity formed!
- If you are an individual in business, the business is not separate from you.
- If you are multiple people, agreeing to work together: then you have formed a partnership, but there has not been a state entity created.
Good so far? Ok, now the main requirements that will affect your business are through taxes. Based on the type of business and how it was formed, the business may elect or be required to be taxed a certain way: which is another business classification.
People often confuse the business formation type, with the business tax type. Not you! Let me know if you have any questions!
For the tax classification:
- Sole Proprietor/Self-Employed: This means the business does not file a separate business return and instead files with the owners personal tax return on a Schedule C. This is the easiest and cheapest option. These rules apply to the following:
- Individuals who simply begin business (not creating a separate state entity),
- Qualified Joint Venture (which allows Married Couples if they meet certain criteria)
- Independent Contractors (who might receive a Form 1099-MISC amounts in box 7)
- Single Member LLC, which means the LLC has only one owner, this is the default tax classification
- Partnership: Whether you simply started working with a few others or you filed with a state, the Partnership must file the partnership tax form 1065. The business then gives each partner a Schedule K-1 to file with their personal tax form. A Multi-Member LLC, which means an LLC with more than one owner, defaults to be taxed as a Partnership.
- Corporation: Tax code has a tax special for corporation businesses. All Corporations must file Form 1120 and pay taxes as required. Then businesses owners receive a 1099-DIV if they received dividends from the business or a W-2 if they work as an employee in the business.
- S-Corporation: 'S-corp' is a tax classification for businesses, which combines features of the partnership and corporation. Businesses must elect to be taxed as a S-Corp and then the business must file Form 1120-S and provide a K-1 to each owner. If the owners also work in the business then they will receive an employee W-2.. The following businesses can elect to be taxed as an S-corp:
- Single Member or Multi-Member LLCs
Most Recommended: The Limited Liability Company (LLC)
The Limited Liability Company (or LLC) is the most recent business type that can be formed under state laws (states have various differences).
The LLC made forming and maintaining businesses easier and cheaper, while still providing owner protection through limited liability. Check out the video and blog post for why to form a LLC, by clicking the title picture.
Essentially, the LLC is a separate business (like it's own person) and in the event the business is sued, the courts can only take business assets and attach to business future earnings. Alternatively, if the owners and managers do not maintain the entity properly by following all rules of formation, then debtors can 'peirce the viel' meaning come after the owner's assets, like home and retirement plan, as well as attach to future earnings.
The reason I highly recommend an LLC is there are far less organizational requirements when it comes to operations. When maintaining the LLC entity, the following records need to be kept:
- Always have an operational agreement
- Maintain separate business and personal bank accounts and credit cards
- Keep a complete and accurate accounting record
- Maintain 'minutes' which document the current plans and agreements of the business
There is no tax code or tax classification for the LLCs. Instead, how the LLC is taxed depends on the number of owners and any election made to be taxed differently.
Check out the video for how a LLC is taxed and the accounting requirements.