When you start a business, it's imperative that you decide what type of business structure you're establishing. It can be sole proprietorship, partnership, corporation, or S corporation. In the United States, a Limited Liability Company (LLC) is a relatively new type of business entity allowed by state statute. Tax and legal considerations enter into the scene when you select a business structure.

Sole proprietorship

Basically, in a sole proprietorship business structure owned, a sole proprietor owns an unincorporated business by himself/herself. However, if you're the sole member of a local LLC, you can't be a sole proprietor if the LLC is elected to be treated as a corporation.

Partnership

This business structure is characterized by a relationship that exists between two or more individuals who create a partnership to carry on a business or trade. Each individual contributes property, money, skill, or labor. Partners expect to share in the profits as well as the losses of the business.

This form of business is required to file an annual report on the income, as well as deductions, gains, and losses from the operations. It doesn't pay income tax though, rather it "passes through" any profit or loss to its partners. Each of the partners includes his/her share of the partnership's income or loss on his or her tax return.

Corporation

In building a corporation, possible shareholders exchange property and/or money for the capital stock of the corporation. It carries on business, realizes net income/loss, distributes profits to its shareholders, and pays taxes. In figuring its taxable income, a corporation in general takes the same deductions as a sole proprietorship.

When earned, profits are taxed to the corporation and when they're distributed as dividends, profits are taxed to the shareholders, creating a double tax. It doesn't get tax deductions when dividends are distributed to shareholders. Moreover, shareholders can't deduct losses of the corporation.

S corporation

A corporation prevents double taxation if it's elected to be treated as an S corporation. An S corporation is generally exempted from federal income tax not including tax on passive income and certain capital gains. The shareholders of S corporations include on their tax returns their share of their corporations' separately stated income, loss, credit, and deduction as well as their share of non-separately stated items of income or loss.

LLC

This business structure is becoming more and more popular because, like a corporation, owners have few personal liability for the LLC's debts and actions. Some LLC features resemble that of partnerships, giving the management more flexibility. The management is also provided with pass-through taxation benefits.