LLC, S-corps, and partnerships
These three structures are commonly grouped together regarding their taxation processes since they are all pass-through entities that utilize Form 1065 and Schedule K-1 for tax filing. While LLCs, S-corps, and partnerships are all separate business structures, they all pass profits and losses directly to the owners.
LLC
LLC owners are referred to as members, and they offer limited liability to the owners but are less susceptible to strict compliance requirements than a corporation.
- This option is best for those wanting to forego the formalities and multitude of paperwork. LLCs are also allowed flexibility on how they will be taxed.
Example:
Assume, for example, that Bob owns a gift shop as an LLC. The gift shop profits pass through to Schedule C of Bob’s personal tax return (Form 1040).
The business profit on Schedule C is added to other income on Bob’s personal return, and that total goes into the tax calculation.
S-corp
S-corp owners are described as shareholders. They issue up to a limited number of stock shares (100) and only in a single class.
- This option is best for those who want the asset protection and ease of conversion that S-corps provide.
Example:
If Bob’s gift shop was set up as an S-corp, he would file Form 1120 as an information tax return. Still, he would pay no corporate income tax but the income would flow through to the owners and be reported on their personal income taxes.
Partnerships
Those involved in a partnership have ownership rights, which means there are multiple people who share the assets and liabilities of the partnership.
- Partnerships are best suited for those who want access to a new market, want to block a competitor, or are looking for help in expansion.
Example:
If Bob’s gift shop was run as a partnership, he would file Form 1065 as an information tax return. Still, he would pay no corporate income tax but the income would flow through to the owners and be reported on their personal income taxes.
Ultimately, the profits generated by all of these businesses flow through to the owners.
Sole proprietorship
With a sole proprietorship, there is no separation between you and your business. This is the default business structure since it happens automatically unless you file for a different structure.
- A sole proprietorship is best for those who don't mind being personally liable for any risks associated with their business.
Example:
As with an LLC, if Bob owns a gift shop as a sole proprietor, the gift shop profits pass through to Schedule C of Bob’s personal tax return (Form 1040).
The business profit on Schedule C is added to other income on Bob’s personal return, and that total goes into the tax calculation.