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Different Entity Structures Reference Guide

Numerous businesses are looking to capitalize on the popularity of virtual currencies. The appeal and interest in launching a start-up in the crypto space is certainly understandable. And with the cryptocurrency space increasing in popularity you would be wise to protect your assets.

Traditionally, how would you go about choosing which entity structure is right for your business?

A company’s legal structure, often referred to as a business entity, is defined as ‘a government classification that regulates certain aspects of a business.’ When assessing legal structures on a federal basis, simply put, your business legal structure determines your tax liability.We generally have four most common types of business entities, those being: sole proprietorships, limited liability companies ‘LLCS’, corporations (C-corporations and S-corporations) and general partnerships. Let’s take the time to jog our memories and run through the taxation liabilities and reporting requirements of the different types of business entities!

Firstly, sole proprietorships are taxed on a pass-through basis. The entity itself does not file a tax return and instead, the income (or loss) passes through and is reported on the owner’s personal tax return through a Schedule C (on Form 1040.) To put it simply, the owner of a sole proprietorship generally takes sole responsibility for any liabilities the business may incur.

Limited liability companies, often referred to as ‘LLCs’ are somewhat a mix between sole proprietorships, general partnerships and corporations. Generally, those who own LLcs are referred to as members. Members of an LLC can range from including individuals to other corporations, LLCs or foreign entities. Similar to sole proprietorships, LLCs are taxed on a pass through basis. Simply put, business income passes through the business and LLC members report their share of profits/losses on their individual income tax returns. Single member LLCs report business expenses on Form 1040 Schedule C, E, or F while multi-member LLCs usually file Form 1065. Unlike sole proprietorships, however, LLCs are required to file an informational tax return. LLC members are “protected” from any personal liability the partnership may incur, often referred to as ‘limited liability’. Simply put,, the personal assets of all LLC members remain untouched in the face of an LLC facing a lawsuit or owing money for any business debts.

Corporations are single handedly the most complex business structures to create, with the two types of corporations being C-Corps and S-Corps. As I’m sure you know, the major difference between these two is… tax treatment! A corporation is defined as ‘a company or group of people authorized to act as a single entity (legally a person) and recognized as such in law’ with ownership being designated by stock issuance. Corporations are a more appropriate entity structure for businesses that are larger and generally well-established, you know, the companies with a lot of employees.

For federal income tax purposes, C-Corporations (‘C-corps’) are recognized as separate tax paying entities. This means that all C-Corps are required to file their own tax return (Form 1120). C-corporations are subject to income tax on all profits, with the entity holding the responsibility of paying all taxes. C-corporation shareholders are also required to pay personal income tax on the profits distributed by the corporation, resulting in what we commonly refer to as “double taxation.” More taxes?! Not ideal, we know! In better news, S-Corporations (‘S-Corps’), elect to pass corporate income, losses, etc. through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. Consequently, allowing S-corps to avoid double taxation on corporate income.

Lastly, general partnerships are defined as ‘ a type of business agreement made between two or more individuals who agree to share all assets, profits and liabilities of the business.’ Generally, due to the simplicity of their creation and tax benefits, partnerships are one of the most common legal business entities. Although partnerships are tax-reporting entities they are not tax paying entities. Even though a partnership is required to report income and losses from operations annually through filing Form 1065, they do not pay federal income taxes. Profits and losses are passed through to owners based on their profit sharing percentages (generally outlined in the Partnership Agreement), with each partner paying taxes on their share of the entity’s profit/loss.

As you can see, there are many enthralling benefits to each entity structure. But, at the end of the day, the type of business entity that will ultimately work for you and your crypto business is a personal decision dependent on both current tax status and long-term vision. We hope you find this helpful, and although this is a brief rundown, we are more than happy to dive deeper on a call. Please feel free to reach out and book a call with any questions you may have.

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