According to The Brookings Institution, about 95% of all U.S. businesses are “pass-through” entities, meaning that all profits and losses are passed through to the owner(s) and reported on their personal tax returns.
The following are descriptions of pass-through business structures with information on how they will affect your taxes.
This business structure is where a single individual owns an unincorporated business.
- All profits and losses are reported on the owner’s personal tax return via the Schedule C.
- Many funding institutions are reluctant to loan money to sole proprietors, which makes it difficult to grow a business.
- With a sole proprietorship comes unlimited personal liability. This business structure has the highest legal risk.
In a partnership, two or more individuals share the profits and liabilities of a business venture.
- All partners might share liabilities and profits equally, or some partners may have limited liability.
- Typically, one of the partners is the “general partner” who manages the business.
- Each partner reports profits and losses on their personal tax returns.
- The partnership then reports each partner’s share of the profit and the dollar value of their share of ownership.
Limited Liability Corporation (LLC)
An LLC is a business structure that protects the members of the corporation from being held personally responsible for the debts and liabilities incurred, while profits are passed through and reported on personal tax returns, similar to partnerships.
- It can be easier to grow the business because an LLC can have an unlimited number of members.
- States require set up and maintenance fees for this business structure.
- You must choose a tax status and create an operating agreement.
- LLCs provide the protections of a corporation with the flexibility of a partnership.
An S Corporation is governed by certain Internal Revenue code requirements, providing 100 shareholders or less the benefit of incorporation while being taxed as a partnership.
- Stocks are issued to owners, making them shareholders, who are protected from many forms of legal liability.
- The number of shareholders is limited.
- The amount of compensation paid to the manager is limited.
- There is extensive tax reporting due to the tax code requirements.