Business Forms that work for you

Business forms are very complicated and the information below is only a sketch of the possibilities available to every business. Be sure to consult with a professional when beginning a new business or filing taxes for them.

Proprietorship. When you start a business the first business form that comes to mind is a proprietorship. This is the most popular single-owner business which does not require outside investors, complete financial statements for outsiders, and other tax returns. The net income from Schedule C flows to page one of the 1040 as pre-tax income and also to the Self-employment schedule for Social Security tax calculations. A Fictitious Name Statement must be registered and published at County level if the name of the business is different than the owner. A married partner is not required to file as a partner but to split the income and expenses into two schedule C schedules [and SE schedules].

General Partnership. As the name implies, this indicates more than one partner. In all partnerships there is a managing general partner and other partners. In a general partnership all partners are equal to their investment in time and money invested. A partnership agreement is required to define investment, responsibilities, and distribution of wages and earnings. A form 565 Partnership return is required annually and there are penalties for late filing. All net income, withdrawals, and guaranteed salaries are distributed via K-1 forms to the partners schedule E and is subject to Self-employment taxes. All participating active partners are subject to lawsuits concerning operations. It must be registered with the state and with the federal for an ID number. A partnership should maintain records showing partner’s contribution, earnings, and withdrawals, for each year.

Limited Liability Company [LLC]. This is another name for a partnership. As the name implies, there would be a general managing active partner and inactive limited partners. Most new LLC businesses however, have only one principal and in that case are still required to file state [California here] partnership returns but can post the profit/loss to Schedule C of the single partner’s federal 1040 returns. This creates an awkward situation because the name implies limited liability while that should only apply to inactive investment partners. [It would be hard in court to blame the partnership on signing the lease with your name on it] ideally, the partnership would involve both general and inactive investment partners, as in an investment limited partnership. A limited partner could only lose his investment but if he was active as an owner I don’t think this would truly apply. The LLC partnership is fined penalties per partner for late filing of returns. An agreement is also required and it must be registered with the state and with the federal [for an ID number]. A partnership should maintain records showing each partner’s contribution, earnings, and withdrawals, for every year. Partners receive a K-1 schedule each year showing guaranteed salaries, withdrawals, and net distributive earnings.

Corporations. The first kind of corporation is a Common corporation [C corp.]. This business can be of unlimited size but generally starts small. This is a legal entity and requires registration with the state where it conducts business and maintains an office or location. Initially a search is done to ascertain that the new business name is not in conflict with an existing business. It provides some liability protection because it is a legal entity. A minute book is required to be set up and maintained annually, a corporate seal is usually obtained, stock certificates are printed and must be registered with the state when issued, an ID number is obtained from the Feds, an information statement of directors and shareholders is filed annually which also shows the agent of process for lawsuit delivery purposes. The corporation files an 1120 Federal form] about ten pages] which shows the amount of income, expense, and taxes owed on net income. It includes a required balance sheet for the larger businesses. Active shareholder officers & managers must be on wages although they can also receive dividends. Because corporations require good record keeping and complicated to maintain, they should only be used for medium-sized businesses that have employees and professional management.

The second kind of corporation is the co-operative which is a very special corporation that acts like a partnership for a specific group of people. Think of Sunkist Growers which markets and distributes citrus products for the benefit of their members who share in the net proceeds proportionally to their activity. I have only seen one of these businesses and it was handled wrongly and I refused to work with them because it did not behave like a co-op. They were soliciting investors publicly the last I heard.

The third kind of corporation is a Qualified Professional Corporation which is composed of professional owners such as doctors and dentists who earn large amounts of money but want professional liability protection [still very limited]. The owners-shareholder professionals should draw a salary and the remaining net income is taxed at a special high rate of 35%.

The fourth kind of corporation is a Subchapter S corporation which allows the owner-shareholder receive passive income net income via a K-1 form. Accordingly, there is some liability protection as a legal entity and the owner should also be on salary [this is generally disregarded in practice however] for his active part of the business and the remainder of the net income flows to Schedule E of his returns without Self-Employment tax liability. Accordingly, the K-1 amount is treated as investment income. This popular corporate form is formed as a C Corp. which requests special status from the IRS by filing form 2553within 2 ½ months of the beginning of the corporate year. The business should be on a calendar year, the same as the partners or officers. All shareholders must agree to the new status. I did a C corp. tax return once for a booming business that had a revolving door of people in the front office. After I sent the return off the business received a letter back stating that the wrong return was filed. One of the departing managers had filed for Subchapter S status and lost the paperwork before he left. I did my homework and remembered that one of the new shareholders was a foreigner. I promptly replied to the IRS that the company was now owned by a foreigner and had disqualified itself for 1120-S filing. Case solved.