The Three Main types of Business Entities in Accounting
Business Entities are classified into three types a Sole Proprietorship, a Partnership, and lastly a Corporation. The type of business entity determines how a business has to file taxes, what methods of accounting to use and who will be liable for the business. Startups in the city of Oregon need to do a thorough research on the legal and tax implications associated with the entity type.
A Sole-Proprietorship setup means all the financial and operational liabilities are on the business owner. Usually, the owner’s personal property is used for the business. If in case the owner will face a financial hardship with regards to the business, his own personal properties will be at risk. Annual income tax returns or ITRs are filed on tax form 1040. Also, the owner is required to file for self-employment taxes. Loss and profits of the business are reported via the owner but, will be taxed for an individual rate. Although sole proprietorship is the simplest to set up, most business owners have to sell the business in order to get back the investment.
Partnerships mean that there are at least two or more owners sharing equal control over the business unless there is an agreement that states only a percentage of control which would mean that it is set up as a limited partnership. Like sole-proprietorship, the losses and profits are reported via the partners and all of them being taxed at individual rates. Operating partners may assume both the legal and financial risks involved. Creditors have the right to attempt and collect debts from other partners’ personal assets. To regain the investment made, a partner is usually required to sell his interest or share in the business to the remaining partners.
Corporation setups can have an unlimited number of owners known as shareholders. In this setup, the business itself is its own entity and is separate from the owners in terms of legal and financial matters. Losses and profits of this setup are taxed at corporate rates instead of individual rates. If the corporation gains profit, it is paid out to its shareholders as income which is taxed at an individual rate. Shareholders in private corporations need to sell their interest to regain the investment. Shareholders in a public corporation can trade their shares in the open stock market.
LLC, the special business type
A Limited Liability Company or more commonly known as an LLC, is a setup to choose specifically for accounting purposes. This structure is a mix between a partnership and a corporation, which means that owners will be protected from personal liabilities but will have the tax advantages of a partnership. This setup is not formally recognized by the federal government for taxation purposes. Businesses listed as an LLC still needs to file taxes classified for the three recognized business types. Form 8832 is filed with the IRS to officially change the LLC classification to another type of business entity classification.’
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