There are three primary forms of business organizations. 1) The sole proprietorship - you own it; you have ALL the risk. 2) The partnership - you share the thrill and the agony with your partners. 3) The corporation - anyone who provides money to you in return for a share of ownership shares the good and bad of your business.
So, what does that really mean? Some of it is obvious, some not.
In a sole proprietorship, you put all the investment into the business. If you have $10 thousand to use to open a business, that's your initial investment; your owner's equity. You get to plan your whole operation and run it. Any profit you make is taxable. Remember that profit is taxed after ALL expenses: materials for your product and the postage stamps to mail invoices and checks. If you lose money, it eats up part of your equity, leaving you with a smaller net worth. If you get sued, you have no protection at all. Your business and all equipment, your home, your investments, your car, your boat and everything else you own can be used to pay the results of a settlement against you. The income tax side of this is pretty simple as well. The federal Schedule C has to be completed as part of your return. Some expenses are specified on the Schedule C. Others are left for you to list on your own. The profit on the Schedule C get reported on the form 1040. There are more tax items associated with a business but they will be discussed in another entry.
In a partnership, you have other people to share this with, but you will most likely also get investment from them, making your business more stable at the outset. The people you have as partners, whether 1 or 20, will also be your resource for sharing the functions of setting up and running the business. This makes a business start-up easier in some respects, but it is necessary to have mutual understandings and similar philosophies to prevent argument and conflict in how to run the various portions of the business. Most often, a partnership will begin with a partnership agreement that spells out various roles each partner will play and how income and losses will be shared. Sometimes, one partner invests more than another. This may lead to an agreement to share profits and losses according to the proportion of each partner's investment. When a partnership prepares its tax return, it is prepared on a form 1065 and has supporting schedules called K-1's. The K-1 is the form that is prepared in multiple pages, one for each partner. The activity on a K-1 has a variety of places it gets reported on the 1040. This helps the accounting profession remain secure and keeps IRS employees secure in their work.
A corporation is an entity (a.k.a. a business) that is owned by one or more stockholders or shareholders. The ownership is based on the amount of money invested by the stockholder. The nice thing about a corporation is that if a corporation is sued, the stockholders' personal assets may not be used toward paying a settlement or judgment resulting from the law suit. The accounting is much the same as other business structures, but the results of business affect "Retained Earnings", a part of the equity or capital of the corporation. If, at the end of the year a business earns a profit, a portion of the profit may be paid to the stockholders as dividends. The amount of profit the corporation keeps for its own use is called "Retained Earnings". Here is where double-taxation comes in. The profit a corporation earns is taxed as corporate profit - ALL of it. The amount of that ALREADY TAXED profit that gets paid to stockholders is taxed AGAIN as dividends. The corporation is required to report a minimum amount of dividends on a form 1099-DIV to you and to the IRS. That way the IRS knows to expect this on your personal return. The corporation files its taxes on a form 1120. There are various forms of corporations that have varying levels of liability and also have tax and legal advantages. Be sure to discuss the options with your accountant to be sure you are making the best choice if you choose to incorporate.
Enough for now. Be sure to write back.
