For each of the business forms, also known as entity types, owners should consider the advantages and disadvantages involving company registration and maintenance, personnel arrangements, separate legal liability, separate in taxation, and overall costs.
1. Sole Proprietorship
- There must be only a single owner.
- There is no need to register as a corporation, however local registration and permits may be required. Thus it is easy to maintain and the most inexpensive option.
- No separate entity (taxation of business income as income of the owner). A single Individual Tax Return allows for an easier tax return process and lower fees. Deductions may include the owner’s health insurance, usage of automobile and home for business, etc.
- The owner is liable for repaying all of the business’s debts and obligations, such as the owner’s personal assets (savings, real property, automobile) could be eligible to pay off remaining debts.
2. Partnership
- A partnership is a business organization with two or more people. Partnerships can take multiple forms, such as general partnerships or limited partnerships. You can choose between a general partner, who is responsible for all the business’s debts, and a limited partner, who has limited liability. However, at least one person must be a general partner.
- Pass-through taxation (taxation of business income as income of the owner).
- All partners are liable for the debts of the business.
- In California, you must pay $800 minimum franchise fee in taxes (even if the income is negative).
3. Limited Liability Company（LLC）
- The LLC provides a flexible and economical option.
- It can be made by a single owner or have multiple partners. The owner has limited liability for the debts of the business.
- Pass-through taxation (taxation of business income as income of the owner) and can have single (Individual) or 2 (Individual, Partnership or Corporation) tax returns.
- In California, you must pay $800 minimum franchise fee in taxes (even if your income is negative).
4. Corporation
- Although we imagine a large company, a corporation is a form of legal and tax regulation, so it can range from giant corporations to small businesses run by one owner.
- Corporations have legal separation from its owners (the shareholders), who elect a board of directors to oversee the business. The officers are appointed for the day-to-day operations of the business. The Corporation can be more complex and have more costs related to business registration and company documentation.
- Corporations are a separate entity for taxation, and therefore have a separate Corporate Tax Return and taxation under Federal and State regulations. In some cases, the C Corporation may have a lower tax rate than individual, while having the Corporation separate from individual could be beneficial such as for non-resident individuals. However, drawbacks may include the non-deductibility of dividends paid to owners and the double taxation at the corporation and individual level.
- In California, you must pay $800 minimum franchise fee in taxes (even if the income is negative).
Election: S corporation (under IRS Subchapter S)
- The Federal Tax Code allows for S Corporation election for small business.
- The primary advantages include avoiding the double taxation while having separation in legal and tax liability.
- It may be a popular choice, however the advantages may not be fully realized without proper execution and accounting under certain conditions. However, under improper conditions, owners may face further complexity and costs.
- Pass-through taxation (taxation of business income as income of the owner) to encourage small business to eliminate double taxation, however 2 tax returns are needed (Corporate and Individual).
- In California, you must pay $800 minimum franchise fee in taxes (even if the income is negative).
