BERKELEY HEIGHTS, N.J. (TheStreet) -- New business owners often pay lip service to mundane details such as entity formation -- meaning how your business will be structured for legal and taxation purposes -- but I urge all would-be business owners to work with legal and financial professionals well-versed in the choices.
A new business can be set up as a sole proprietorship, general partnership, limited liability partnership, single-member LLC, multimember LLC, S corporation or C corporation. Selecting the right legal entity really is unique to each business and depends on the circumstances.
A person who starts a business without even making a choice has actually chosen to be a sole proprietor. A sole proprietorship is simple from an administrative perspective and does not require the services of an attorney to form, but generally makes sense only in the simplest of circumstances. The downside is you have unlimited exposure to business problems on a personal level. For tax purposes, an owner reports the tax results on their personal income tax return on IRS Schedule C and typically needs to make quarterly estimated personal income tax payments. In addition, the sole proprietor pays self-employment taxes (FICA) calculated on his or her self-employment income when filing an annual tax return. If the sole proprietor has W-2 employees, payroll taxes and withholdings are handled like any other business entity.
A general partnership is when two or more people start a business. Each partner has unlimited personal liability in a partnership, including on professional malpractice. Even though a partnership pays no taxes, an informational partnership tax return is filed with the IRS on Form 1065. Each partner gets a K-1 from the partnership picking up their share of the partnership's results and will typically need to make quarterly estimated personal income tax payments. Partners also pay their self-employment taxes calculated on their partnership income when filing their personal return. If the partnership has W-2 employees they must handle payroll taxes and withholdings like any other business entity. To avoid the unlimited liability of general partnerships, many professionals such as doctors, lawyers and accountants form limited liability partnerships. A partner in an LLP is not liable for the malpractice of the other partners, but remains liable for their own acts.