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Business Forms

There are two basic types of taxpayers, individual and corporate, but several forms of businesses. Business entities are further broken down into either "taxable entities" or "conduit entities." Taxable entities must pay a tax based on their taxable income, whereas a conduit entity is one in which the tax attributes (income, deductions, losses, credits) of the entity flow through the entity to the owner(s) and are reported on the owner's individual tax return. All but the C corporation are conduit entities.

Under common law there are certain characteristics that are looked at to indicate that a business entity actually exists:

• The activity is carried on for livelihood or profit
• That a profit motive is clearly present
• Some type of economic activity must be involved
• The activity is not engaged in purely for personal satisfaction
• Activities are carried out on a continuous basis
• The activity has regular transactions that produce income
• Continuous losses from little or no income raises questions about the existence of a business

Income taxation is only one factor to consider when an economic decision must be made. There are several non-tax factors that should be considered when making the choice of the appropriate business form:

• The number of owners - The number of current and potential future owners can restrict the choice of the entity.

• Limited personal liability - An investor's personal assets are not at risk to cover liabilities incurred by the entity. Limiting personal liability is often the most important factor for investors choosing a legal form for operating their business.

• Freedom to choose how to transfer ownership - The transferability of ownership interest refers to the ease with which ownership can be transferred. In certain situations, placing restrictions on the buying and selling of an ownership interest may be desirable. Most restrictions generally occur with closely held businesses.

• Anticipated life of the enterprise - Continuity of life refers to whether an entity continues to operate or technically dissolves and ceases to exist in its present form when a change occurs in the ownership structure. State law dictates whether an entity continues or technically dissolves if its ownership structure changes. Under most state laws partnerships technically dissolve when ownership changes.

• Ability to participate in business management - The degree of management control varies across different entities. Corporations use centralized management structures, partnerships use a broad-based management in which all partners have the right to participate in management decisions.

• The cost of organizing the entity - The cost of organizing each entity varies according to legal requirements. In general, corporations are more costly to organize than are sole proprietorships; partnerships cost more than sole proprietorships but less than corporations

• Ability to raise capital - Each entity has legal characteristics that can affect the ability of the entity to raise additional capital should the need arise.

These non-tax factors arise primarily because of the legal differences in the various entity forms.