Choosing a business structure is partly a legal decision and partly a tax decision. The structure you choose affects which federal returns you file, how profits reach you and what records you need. This guide summarizes the common structures from a tax perspective. It is not a recommendation for any particular business. Talk to a qualified professional before making or changing your choice.

Where to start

The IRS page on business structures explains that when beginning a business, you must decide what form of business entity to establish. Your form of business determines which income tax return form you have to file. The most common forms are the sole proprietorship, partnership, corporation and S corporation. A limited liability company (LLC) is a business structure allowed by state statute.

The U.S. Small Business Administration's guide to paying taxes is another helpful starting point for federal, state and local tax obligations.

Sole proprietorship

A sole proprietor is someone who owns an unincorporated business by themselves. From a tax perspective, business income and expenses are generally reported on the owner's individual return, and the owner may owe self-employment tax on net earnings. The IRS Publication 334 is the main federal guide for sole proprietors.

Bookkeeping tip: even though the business is not a separate entity for tax purposes, keep separate business bank and card accounts. It makes your records far easier to support.

Partnership

A partnership is a relationship between two or more people who join to carry on a trade or business. The partnership generally files an information return, and profits and losses pass through to the partners, who report their shares on their own returns.

Bookkeeping tip: partner contributions, draws and allocations need careful tracking. Errors here are among the most common in small partnerships.

Corporation

A corporation is generally a separate taxable entity. It files its own return and pays tax on its profits. Shareholders may also be taxed when profits are distributed as dividends. Corporations have more formal recordkeeping and governance requirements.

S corporation

An S corporation is a corporation that elects to pass corporate income, losses, deductions and credits through to its shareholders for federal tax purposes. Shareholders report their share on their individual returns. Owners who work in the business are generally expected to be paid wages through payroll, which brings employment tax responsibilities. Our guide to employment taxes explains what payroll involves.

Limited liability company (LLC)

An LLC is created under state law. For federal tax purposes, the IRS explains that an LLC is treated as a corporation, partnership or disregarded entity depending on the number of members and any elections it makes. That flexibility is one reason LLCs are popular, but it also means two LLCs can be taxed very differently.

If you operate in Texas, note that the Texas franchise tax applies to many entities formed or doing business in the state. See our Texas page for an overview with official Comptroller links.

Questions to discuss with a professional

  • How do you expect profits to grow over the next few years?
  • Will you have employees, and will you work in the business yourself?
  • Do you plan to bring in partners or investors?
  • What liability protection do you need?
  • What state rules apply where you are formed and where you do business?

Records each structure needs

Every structure needs reliable books, but the details differ. Partnerships need capital account tracking; S corporations need payroll for working owners; corporations need records of distributions and formal actions. Our accounting services and bookkeeping services can keep the records your structure requires. Book a free consultation to talk it through.