Sole Proprietorship
Most small businesses fall under this category, which is the easiest to set up due to its simple and informal structure. One person owns all the assets and profits of the business. The owner reports business income and losses on their personal income tax return using Schedule C (Form 1040).
Under a sole proprietorship, the business is not a separate legal entity from the owner. The owner is personally liable for all business debts and obligations.
Partnership
Partnerships are similar to sole proprietorships, except there are at least two owners. Like a sole proprietorship, the business and its owners are legally indistinguishable. Partners can split profits and liabilities according to a Partnership Agreement.
Partnerships do not pay federal income tax at the entity level. Instead, the individual partners report their share of profits or losses on their personal tax returns using Schedule K-1 (Form 1065).
Common types of partnerships include:
- General partnership: Partners share profits and liabilities equally, unless otherwise stated in the partnership agreement.
- Limited partnership (LP): At least one partner manages the business and assumes liability, while limited partners’ liability is restricted to their investment.
- Joint venture: Similar to a general partnership but formed for a single project or limited duration.
C-Corporation
A C-Corporation (C-Corp) is a distinct legal entity that can own property, enter contracts, sue or be sued, and pay taxes. Shareholders (owners) have limited liability for corporate debts, although officers may be held personally responsible for their own actions.
C-Corporations are subject to corporate income tax, and their shareholders pay tax again on dividends they receive — often referred to as “double taxation.” Corporations must also adhere to more complex recordkeeping and regulatory requirements than other business types.
S-Corporation
An S-Corporation (S-Corp) is similar to a C-Corporation in structure but differs in how it is taxed. S-Corporations are pass-through entities, meaning profits and losses are reported on shareholders’ personal tax returns instead of being taxed at the corporate level.
S-Corporations must meet certain IRS requirements, including:
- Having no more than 100 shareholders.
- Having only allowable shareholders (such as individuals or certain trusts and estates).
- Being a domestic corporation.
- Having only one class of stock.
For more information, please visit our page on How an S-Corporation is Taxed, as well as our page on the differences between S-Corporations and C-Corporations.
Limited Liability Company
An Limited Liability Company (LLC) is a hybrid business structure that combines characteristics of corporations and partnerships.
By default:
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A single-member LLC is taxed as a sole proprietorship.
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A multi-member LLC is taxed as a partnership. However, LLCs may choose to be taxed as a C-Corporation or S-Corporation by filing the appropriate IRS election forms.
LLCs only exist for a limited period. If a member leaves the LLC, the LLC dissolves. This can be prevented by the LLC operating agreement or the remaining founders can simply reform the LLC. Additionally, all members of an LLC are considered self-employed for purposes of taxation. They must contribute independently towards items like Medicare and Social Security.
Beginning an LLC is generally less costly than an S or C-Corp, and the registration paperwork is less burdensome. LLCs have fewer restrictions when it comes to profit sharing amongst members. Members decide amongst themselves through an operating agreement how to divvy profits and losses.
Please note: This page offers general legal information, not but not legal advice tailored for your specific legal situation. Rocket Lawyer Incorporated isn't a law firm or a substitute for one. For further information on this topic, you can Ask a Legal Pro.
