Sole Proprietorship
A sole proprietorship is the simplest form of business structure. It may be suited to the start up a one-person business. It is more flexible than either the partnership or the corporation. However, all business responsibilities are those of the single owner. This includes unlimited financial liability incurred by the business.
Tax Obligation
Self-Employment Tax: This tax is similar to the Social Security tax withheld from wage earners. Self-employment tax is based on net of $400 or more. Currently, the self-employment tax rate is 15.30%. This rate is separated into the Social Security portion (12.40%) and the Medicare portion (2.90%). The Maximum net earnings subject to Social Security is $87,000. There is no maximum limit to the amount subject to Medicare. All net earnings for self-employment are subject to the Medicare part of the tax.
Estimated Tax: If the total of estimated income tax and self-employment tax for the year exceeds total withholding and credits by $500 or more, you may be required to make federal estimated tax payment. The threshold for determining when to pay estimated tax payments for New York State is $100. On the federal and state personal income tax returns, income from the business is considered business income rather than wage or salary.
Partnership
A partnership is the relationship between two or more persons or companies that carry on a trade or business together. Personal liability is joint and individual for the general partners who are responsible for the obligations of the partnership.
The life-span of the business is for a designated period stipulated in the partnership agreement or until a dissolution event occurs, subject to any right to continue that may be stated in the partnership agreement. In the absence to a partnership agreement, the New York State Partnership law sets forth the rights and duties of the partners.
Tax obligations:
For purpose of taxation- partnership is not treated as a separate taxable entity; business income is taxed through each general partner's personal tax return.
See, Self-Employment Tax and Estimated Tax under Sole Proprietorship
Partnerships are required to file both Sate and federal partnership returns. In addition, partners should include their share of the partnership income on their State and federal personal income tax returns. Income from a partnership is considered business income rather than wages or salaries.
Limited Liability Partnership [LLP]
A Limited Liability Partnership is the relationship between two or more persons or companies that carry on a trade or business together. Personal liability is joint and individual for the general partners who are responsible for the obligations of the partnership; limited partners are liable to the extent of their capital contribution to the partnership.
The life-span of the business is for a designated period stipulated in the partnership agreement; or until a dissolution event occurs, subject to any right to continue that may be stated in the partnership agreement
Tax obligations:
For purpose of taxation- LLP is not treated as a separate taxable entity; business income is taxed through each general partner's personal tax return.
See Self-Employment Tax and Estimated Tax under Sole Proprietorship
LLPs are required to file both Sate and federal partnership returns. In addition, partners should include their share of the LLP income on their state and federal personal income tax returns. Income from a LLP is considered business income rather than wages or salaries.
Limited Liability Company [LLC]
Limited Liability Companies s have long been a traditional form of business structure in Europe and Latin America. LLCs were first introduced in the United States by the state of Wyoming in 1977 and authorized for pass- through taxation (similar to partnerships and S Corporations) by the IRS in 1988. With the recent inclusion of Hawaii, all 50 states and Washington, D.C. have now adopted some form of LLC legislation for both domestic and foreign (out of state) limited liability companies.
Many business professionals believe LLCs present a superior alternative to corporations and partnerships because LLCs combine many of the advantages of both. Those advantages would include:
• Corporate liability protection of the owners for their personal assets from business debt as well as the tax advantages of partnerships or S Corporations,
• Protection of personal assets from business debt,
• Profits/losses pass through to personal income tax returns of the owners,
• Great flexibility in management and organization of the business,
• LLCs do not have the ownership restrictions of S Corporations making them ideal business structures for foreign investors.
Tax obligations:
For purposes of taxation, an LLC can elect its classification for federal tax purposes. An LLC with two or more members can elect to be an association (corporation) or a partnership; an LLC with only one member can elect to be an association (corporation) or elect to be disregarded as an entity separate from its owner (in effect, to be treated as a sole proprietorship for federal tax purposes).
General Corporation
This is the most common corporate structure. The corporation is a separate legal entity that is owned by stockholders. A general corporation may have an unlimited number of stockholders whom, due to the separate legal nature of the corporation, are protected from creditors of the business.
Advantages would include:
• A stockholder's personal liability is usually limited to the amount of investment in the corporation and no more.
• Owners' personal assets are protected from business debt and liability.
• Corporations have unlimited life extending beyond the illness or death of the owners.
• Tax free benefits such as insurance and retirement plan deductions.
• Transfer of ownership facilitated by sale of stock.
• Change of ownership need not affect management.
• Possibility to raise capital through sale of stocks and bonds.
Tax obligations:
For purposes of taxation a corporation pays state franchise taxes and taxes on income; shareholders pay taxes on income distributed as dividends (a limited exception exists for "Subchapter S" corporations).
For more information on state taxes:
New York State Department of Taxation at http://www.tax.state.ny.us/sbc/
For information on federal business taxes:
Internal Revenue Service at http://www.irs.gov/business/index.html
Close Corporation
This type of corporation is particularly well suited for a group of individuals who will own the corporation with some members actively involved in the management and other members only involved on a limited or indirect level.
There are a few minor, but significant, differences between general corporations and close corporations.
In most states where they are recognized, close corporations are limited to 30 to 50 stockholders. In addition, many close corporation statutes require that the directors of a close corporation must first offer the shares to existing stockholders before selling to new shareholders.
Tax obligations:
See General Corporation
S Corporation
(To qualify for 'S' corporation status, all shareholders must be citizens or permanent residents of the US.)
With the Tax Reform Act of 1986, the S Corporation became a highly desirable entity for corporate tax purposes. An S Corporation is not really a different type of corporation. It is a special tax designation applied for and granted by the US Internal Revenue Service [IRS] to corporations that have already been formed. Many entrepreneurs and small business owners are partial to the S Corporation because it combines many of the advantages of a sole proprietorship, partnership and the corporate forms of business structure.
Tax obligations:
S Corporations have the same basic advantages and disadvantages of general or close corporation with the added benefit of the S Corporation special tax provisions. When a standard corporation (general, close or professional) makes a profit, it pays a federal corporate income tax on the profit. If the company declares a dividend, the shareholders must report the dividend as personal income and pay additional taxes.
In short, shareholders in an S Corporations enjoy the same protections as shareholders in a regular corporation &, at the same time, get the tax benefits of a partnership - profits & losses 'drop down' directly to the income of the shareholders, thus there is no 'double taxation'.
S Corporation Restrictions
To elect S Corporation status, your corporation must meet specific guidelines. As a result of the 1996 Tax Law, which became effective January 1, 1997, many of these qualifying guidelines have been changed. A few of these changes are noted below:
Prior to the 1996 Tax Law, the maximum number of shareholders was 35. The maximum number of shareholders for an S Corporation has been increased to 75. Previously, S Corporation ownership was limited to individuals, estates, and certain trusts. Under the new law, stock of an S Corporation may be held by a new "electing small business trust."
All beneficiaries of the trust must be individuals or estates, except that charitable organizations may hold limited interests. Interests in the trust must be acquired by gift or bequest -- not by purchase. Each potential current beneficiary of the trust is counted towards the 75-shareholder limit on S Corporation shareholders. S corporations are now allowed to own 80 percent or more of the stock of a regular C corporation, which may elect to file a consolidated return with other affiliated regular C corporations. The S Corporation itself may not join in that election. In addition, an S Corporation is now allowed to own a "qualified subchapter S subsidiary." The parent S Corporation must own 100 percent of the stock of the subsidiary. Qualified retirement plans or Section 501(c)(3) charitable organizations may now be shareholders in S Corporations.
All S Corporations must have shareholders who are citizens or residents of the United States. Nonresident aliens cannot be shareholders. S Corporations may only issue one class of stock. No more than 25 percent of the gross corporate income may be derived from passive income. An S Corporation can generally provide employee benefits and deferred compensation plans. S Corporations eliminate the problems faced by standard corporations whose shareholder-employees might be subject to IRS claims of excessive compensation.
Not all domestic general business corporations are eligible for S Corporation status. These exclusions include:
• A financial institution that is a bank;
• An insurance company taxed under Subchapter L;
• A Domestic International Sales Corporation (DISC); or
• Certain affiliated groups of corporations.
If you have any questions, feel free to contact us by e-mail, telephone or fax.
