Business Entities

Several different forms of businesses have been made available to taxpayers over the years. Each of these business forms has characteristics that are favorable or unfavorable to the taxpayer.

Sole Proprietorship:

1. The sole proprietorship is the most common form of business entity.

• A sole proprietorship is not a legal entity separate and apart from its owner.
• Sole proprietorships are easy to establish and require no special forms.
• The owner has unlimited liability with regard to the sole proprietorship.
• Income/Loss is reported by the taxpayer on Schedule C of the owner's form 1040.
• The business can't be transferred, if the business is sold and the owner reports as if each asset were sold.
• spouses filing a joint return may elect out of partnership treatment by choosing to be a qualified joint venture.

Corporations:

1. Corporations were created to allow for the limited liability of the owners. The owners' personal assets are protected from creditors. Creditors can only look to the assets of the corporation for settlement of debts.

• Regular corporations are referred to as C corporations.
• C corporations have double taxation:

1. First, the income is taxed to the corporation as it is earned.
2. Second, the income is taxed when the corporation distributes the income in the form of dividends.

• A corporation is closely held if both of the following apply:

1. It is not a personal service corporation.
2. At any time during the last half of the tax year, more than 50% of the value of its outstanding stock is directly or indirectly owned by or for five or fewer individuals. "Individuals" includes certain trusts and private foundations.

The due date of the return is 04/15.

S Corporations:

1. the S corporation is a special type of corporation that first became available as a business form in 1958.

• The S Corporation is not taxed, but the income is taxed to shareholders when earned by the S Corporation.
• The S Corporation has the limited liability feature of the C corporation. However, there are several ownership restrictions placed on the S Corporation.
• S Corporations comprise over one-half of all corporations:

1. S Corporation tend to be small in size and number of owners.
2. Over half of all S Corporation have only one owner.
3. For the most part, S Corporations are required to be on a calendar tax year.
4. The due date of the return is 03/15.

Partnerships:

1. There are several forms of partnerships available for taxpayers.

a) General Partnerships:

Partnerships have the advantage that income is taxed only once.

• The partnership does not have to pay taxes, the income flows through and is taxed on each owners' personal tax return.
• The main disadvantage of the partnership form of organization is that the owners can be held liable for the partnership's debts if there are not enough assets to cover the partnership liabilities. This form of partnership is referred to as a general partnership.
• The due date of the return is 03/15.

b) Limited Partnership:

• The owners are divided into general partners and limited partners. Only the limited partners have the limited liability feature.
• However, the limited partner is not allowed to participate in the operations of the business.

c) The Limited Liability Partnerships:

• The limited liability partnership is primarily used by personal service taxpayers.
• Several states require that the owners remain personally liable for the contracted debts of the entity.

Limited Liability Companies (LLC):

1. An LLC is a noncorporate hybrid business structure that combines the limited liability of a corporation with the tax advantages of a general partnership.
2. An LLC is a domestic entity that is not specifically classified as a corporation, is classified as a partnership (if it has two or more members) or is disregarded as an entity separate from its owner (it has only one owner). For federal tax purposes the default classification for a domestic LLC with at least two members is to be treated as partnerships. However, the check-the-box regulations allow an LLC to elect to be treated as a corporation.

• LLCs are the only business entities that allows:

1. Complete pass-through tax advantages and the operational flexibility of a partnership,
2. Corporation-style limited liability under state law,
3. No restrictions on the number or types of members, and
4. Management participation by all members. Members are the owners or shareholders of the LLC.

• LLCs allow the inclusion of entity-level liabilities in tax basis.
• An LLC doing business out of state may have to live with unacceptable uncertainty as to its legal status. Every state and the District of Columbia permit a single-member LLC.

Single-Member LLC:

1. A single-member LLC is generally treated as a disregarded entity unless it elects to be taxed as a corporation.
2. For individuals, the profit or loss from a disregarded entity is simply reported on Schedule C of the member's form 1040 along with Schedule SE.

• For businesses, the profit or loss from a disregarded entity is reported on the member's return as an unincorporated branch or division of the member.

Entity Classification Election -- Check-the-box Regulations:

1. An eligible entity can use Form 8832 to elect how it will be classified for federal tax purposes: as a corporation, a partnership, or an entity inseparable from its owner.

• An eligible entity is classified for federal tax purposes under the default rules unless it filed Form 8832 or Form 2553 to elect a classification or change its current classification.
• Unless an election is made on Form 8832, a domestic eligible entity is:

1. A partnership if it has two or more members
2. Disregarded as an entity separate from its owner if it has a single owner

• Unless an election is made on Form 8832, a foreign eligible entity is:

1. A partnership if it has two or more members and at least one member does not have limited liability
2. An association taxable as a corporation if all members have limited liability
3. Disregarded as an entity separate from its owner if it has a single owner that does not have limited liability

• A corporation organized under a state law can only be taxed as a corporation. However, the entity may be eligible to be classified as an S Corporation.

Trusts and Estates:

1. Trusts and Estates are separate entities from its owners.

• Trusts may be created to hold assets for the beneficiaries.
• The trust income is usually distributed to the beneficiaries.
• The beneficiary pays an income tax on the income of the trust that is required to be distributed.
• The trust only pays tax on income that is not required to be distributed. Thus, the income of a trust is taxed only once.

1. an estate comes into place after the taxpayer dies.

• The estate is required to pay tax on income that is earned on the asses of the decedent before the assets are distributed to the beneficiaries.
• Similar to the trust, the beneficiaries pay the tax on any income that is distributed, and estate pays tax on the remaining income.

Employer Identification Number (EIN):

1. An EIN is the business/entity equivalent of a taxpayer's identification number (TIN).

• Use Form SS-4 to apply for an EIN. An EIN is a nine-digit number assigned to sole proprietors, corporations, partnerships, estates, trusts, and other entities for tax filing and reporting purposes.