One of the most common questions from a person starting a business is what type of entity should I be. I would say that in 90% of the cases that is more a legal question than an accounting or tax one. You have several options:
-Sole proprietorship- You are the business. No separate structure. Talk with a lawyer about legal liability. All net income (profit) is subject to self-employment tax.
-Corporation- A separate entity with legal requirements to maintain meetings, etc. It can be taxed two ways:
- As a C Corporation- Income tax is assessed on the Corporations via its income tax return. Payments to shareholders are taxed as dividends at the shareholder level. This can lead to double taxation and is why C corporations are often avoided.
- As an S Corporation- A separate tax return is prepared but income tax is assessed at the shareholder level. Active shareholder/employees are required to take a reasonable salary. The rest of the net income is not subject to self-employment taxes. That is where the potential tax benefit of S Corporations comes in to play.
-LLC- An LLC can be setup several ways.
- With only one member (owner) it can be considered a disregarded entity and be taxed as a sole proprietorship. It can be treated the same way if owned 100% by a husband and wife.
- With more than one owner it can be elect to be treated as a partnership. This results in a separate tax return but net income of all active partners is subject to self-employment tax on their personal returns.
- It can elect to be taxed as an S Corporation.