The first step an entrepreneur must do when starting a business is to decide the type of business they will form. There are many factors that should be considered including both business and tax factors. An entity can be set up as one of the following business types:
• Sole proprietorship;
• S corporation;
• C corporation;
• Nonprofit; and
A business trust is generally used for a large business that is unincorporated, it operates under a declaration of trust, and is managed by appointed trustees. A business trust is treated as a corporation for all tax purposes.
A sole proprietorship is when a single person is the owner of the company, and is liable, both fully and personally for the business. There are many benefits to sole proprietorship, such as easy tax preparation, it is the simplest and easiest to form, and the owner has complete control over the company. There are a couple of disadvantages as well that include, the owner is responsible for all financials including debt, and the owner can be sued personally if the company is sued.
An S corporation is a regular corporation but the federal taxation is different. An S corporation does not pay federal income taxes, instead, the taxes pass through the shareholders to claim individually. There are different qualifications that are required for a business to be classified as an S corporation. These requirements include:
• Be a domestic corporation;
• Not be an ineligible corporation;
• Have one class of stock; and
• Have only 100 shareholders (cannot be partnerships, corporations or alien shareholders).
A C corporation is different than an S corporation because it is taxed separately from the owners of the corporation and unlike the S corporation, a C corporation can have unlimited shareholders. The disadvantage of C corporation is that the profits of the business are taxed both when it is earned by the company, and when the shareholders receive the funds.
A nonprofit is a company that conducts business, but does not make a profit, and the funds are not transferred to the owner/s. Traditionally a nonprofit is formed to serve a public benefit. Examples of a nonprofit are religious organizations, charities, professional or trade associations, foundations, and advocacy groups.
The last type of business that can be formed is a partnership, which is a business that has at least two people that contribute to the company by way of labor, money, property. All partners in the company share in both profits and loss within the business.
Entrepreneurs retain a business attorney to discuss their business in detail, and advise them on what type of business best fits their needs.