By Thomas Van Blunk and Jaclyn Martello

When it comes to the formation of a business there are many rules and regulations that must be followed. These procedures can change widely depending on the type of business you decide to form and its location within the country. This blog provides a basic overview on how to form a business and includes key rules and regulations related to business formation.

When starting a business, you must first decide what kind of business you want to form. There are many types of business structures, but the most popular ones are: 

• Sole Proprietorship
• Partnership
• C Corporation
• S Corporation
• Limited Liability Company

Sole Proprietorship

A sole proprietorship is an unincorporated business that is owned and operated by one person. There are various tax forms that a sole proprietorship may be required to file in both the federal and state governments.

According to the IRS, here are some forms a sole proprietorship may need to file:

Type of Tax	Forms
Income Tax	1040, U.S. Individual Income Tax Return or 1040-SR, U.S. Tax Return for Seniors Schedule C (Form 1040 or 1040-SR), Profit or Loss from Business
Self-Employment Tax	941, Employer’s Quarterly Federal Tax Return 943, Employer’s Annual Federal Tax Return for Agricultural Employees 944, Employer’s Annual Federal Tax Return
Estimated Tax	1040-ES, Estimated Tax for Individuals
Social Security and Medicare taxes and income tax withholding	941, Employer’s Quarterly Federal Tax Return 943, Employer’s Annual Federal Tax Return for Agricultural Employees 944, Employer’s Annual Federal Tax Return
Providing information on Social Security and Medicare taxes and income tax withholding	W-2, Wage and Tax Statement (to employee) W-3, Transmittal of Wage and Tax Statements (to the Social Security Administration)
Federal Unemployment (FUTA) Tax	940, Employer’s Annual Federal Unemployment (FUTA) Tax Return
Filing information returns for payments to nonemployees and transactions with other persons	Depends on the business
Excise Taxes	Depends on the business

Your local state’s tax website will have all the information you will need to file the proper state tax forms.

Partnership

A partnership is a formal business relationship between two or more people with the purpose of forming a business or trading. In a partnership, all partners are responsible for sharing both the risks and the benefits associated with managing and contributing to the business. The IRS regulates how income is reported for a partnership. To properly report income to the IRS, a partnership must complete and send an annual information return, which reports income, expenses, and other operational transactions; although, partnerships do not need to pay income tax with these returns. Since each partner reports their share of profit and loss on their own individual tax return, it’s important for partners to get K-1s to provide the necessary information to file their personal income taxes. A partnership also requires a mutual agreement, whether oral or written, that is accepted by all the partners. This agreement can be modified after the end of the partnerships tax year. 

According to the IRS, here are some forms a partnership may need to file:

Type of Tax	Forms
Annual Return of Income	Form 1065, U.S. Return of Partnership Income
Employment Taxes	Form 941, Employer’s Quarterly Federal Tax Return For farm employees: Form 943, Employer’s Annual Federal Tax Return for Agricultural Employees Federal unemployment (FUTA) tax: Form 940, Employer’s Annual FUTA Employment taxes: Depositing and reporting employment taxes 1099-NEC if the business has nonemployee compensation
E-file	1099 E-file
Excise Taxes	Form 965-A, Individual Report of Net 965 Tax Liability Form 8990, Limitation on Business Interest Expense Under Section 163(j)

In addition, if you are a partner in a partnership, the IRS may have you fill out the following forms: 

Type of Tax	Forms
Income Tax	Form 965-A, Individual Report of Net 965 Tax Liability Schedule E (Form 1040), Supplemental Income and Loss Form 1040, U.S. Individual Income Tax Return or Form 1040-SR, U.S. Tax Return for Seniors
Self-Employment Tax	Schedule SE (Form 1040), Self-Employment Tax Form 1040, U.S. Individual Income Tax Return or Form 1040-SR, U.S. Tax Return for Seniors
Estimated Tax	Form 1040-ES, Estimated Tax for Individuals
International Tax	Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations and related schedules Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR) Form 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships

Your local state’s tax website will have all the information you will need to file the proper state tax forms. 

Corporation

Another popular business structure is a corporation. The most common corporations are C corps and S corps. When forming a corporation, prospective shareholders exchange money, property, or both for the corporation’s capital stock. A corporation will have to file articles of corporation in its local state to become a formal corporation. A corporation usually gets the same deductions as a sole proprietorship and may qualify for some special deductions. A C corporation is seen as a separate taxing entity for the federal income tax.

A corporation does the following:

• Conducts business.
• Realizes profit and loss.
• Pays taxes.
• Distributes profits to the shareholders as dividends.

Profits generated by a corporation are taxed when earned at the corporate tax rate. A corporation’s taxable income can be offset by the business’s expenses. As for shareholder income, a portion of the corporation’s earnings are distributed to the shareholders as taxable dividends. These dividend distributions are then considered to be taxable income to the shareholders and are taxed at individual rates. The shareholder’s resulting income can be decreased by personal liabilities, only, and not the business’s liabilities. It’s also important to remember that distributions to shareholders are not considered to be a deduction, or expense for the business; a corporation’s income cannot be reduced by its distributions. As you can see, this creates a double tax on a corporation’s profits.

C Corporation

According to the IRS, here are some forms a C corporation may need to file: 

Type of Tax	Form
Income Tax	1120, U.S. Corporation Income Tax Return
Employment Taxes	941, Employer’s Quarterly Federal Tax Return or 943, Employer’s Annual Federal Tax Return for Agricultural Employees (for farm employees) 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return
Excise Tax	Depends on business

Your local state’s tax website will have all the information you will need to file the proper state tax forms. 

S Corporation

An S corporation differs from other corporations by allocating its day-to-day profits and expenses directly to its shareholders for federal tax purposes. It is then the duty of the shareholders to report the S corp’s income and losses on their personal tax returns. This enables shareholders to avoid paying the double tax on the corporate income, since they report the taxes of the corporation.

For a corporation to be recognized as a S corporation, they must meet the following requirements as listed by the IRS:

• Must be located within the United States.
• Shareholders must be individuals, certain trusts, and estates.
• Shareholders cannot be partnerships, corporations, and foreign residents.
• Must have no more than one hundred shareholders. 
• Only give out one class of stock.
• Not be a corporation that is non-eligible depending on what kind of business they do.
• Must fill out and submit Form 2553, Election by a Small Business Corporation and have all shareholders of the corporation sign it.

According to the IRS, here are some forms an S corporation may need to file:

Type of Tax	Form
Income Tax	1120-S 1120-S (Sch. K-1)
Employment Taxes	941 or 943 (for farm employees) 940
Excise Taxes	Depends on business

In addition, if you are a shareholder of an S corporation, you may need to fill out the following forms:

Type of Tax	Form
Income Tax	1040 or 1040-SR and Schedule E and other forms referenced on the shareholder’s Schedule K-1
Estimated Tax	1040-ES

Your local state’s tax website will have all the information you will need to file the proper state tax forms. 

Limited Liability Company

There is one type of business with a structure permitted only by state laws, and this is a Limited Liability Company (LLC). You can find information about your state’s laws and regulations on your state’s tax website. LLCs have minimal regulations regarding ownership, which allows for an unlimited number of owners. In addition, many states also recognize single member LLCs. Since LLCs are formed by state statute rather than federal, the IRS can classify them as a partnerships, corporations, or a part of the owner’s individual income tax return. This classification is dependent upon the choices the LLC has made and the number of owners it has. This classification also determines whether the LLC will be required to pay taxes that non-LLCs in its classification must pay. If an LLC wants to change its classification, they can do so by filing Form 8832, Entity Classification Election.

How To Form a Business

Here is some general information on starting a business:

• Register your business on your home state’s registration page
  • Choose your name and business structure
• Apply for an EIN or employer ID number – this is free and quick on the IRS website
• Apply for a state tax ID if applicable
• Keep good records of day-to-day operations to back-up your federal return
• Determine tax year
  • Calendar year (January to December)
  • Fiscal year (52-53 weeks)

Once you have completed the steps above, you can file your first tax return of the year. 

This information has been prepared for informational purposes only, and is not intended to provide, and should not be relied upon for tax, legal, or accounting advice. If you have any questions regarding the formation of a business, please do not hesitate to contact us at Lear & Pannepacker.