Choosing a Family Business Structure

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You’re newly retired—but not quite ready for retirement. So you’re thinking of turning the hobby you and your spouse enjoy into a business. What type of business structure can you choose for your new family endeavor?

Generally, family businesses with a clear business purpose and profit motive have the same entity choices as other businesses. Here are three.

Sole proprietorship. While the definition of a sole proprietorship is an unincorporated business with one owner, the Small Business and Work Opportunity Tax Act of 2007 created an exception for husband and wife businesses. If the two of you are the only members of the business and you both participate, you can agree to treat your business as a sole proprietorship.

You’ll include a separate tax form (Schedule C) for each of you in your personal income tax return, and you both get credit for social security earnings generated by your business.

Partnership. For tax purposes, a partnership is a separate entity composed of two or more individuals, estates, trusts or corporations.

If you establish a partnership, your business will file its own tax return. However, the partnership itself does not pay income tax. You and your spouse report your respective portion of the business income on your personal tax return, and pay any related tax.

Corporation. You can choose to incorporate your family business as a “C” corporation or an “S” corporation. The letter designations come from the applicable tax code sections that spell out the income tax requirements.

C corporations file corporate tax returns and pay any income tax due on the corporate net income. S corporations also file corporate income tax returns, but the net income is passed through to you and your spouse as shareholders. With an S corporation, you report the income on your personal tax return and pay the related tax.

You may also choose to set up your family business as a limited liability company, a family trust or a family partnership. Each entity type has legal pros and cons, along with tax benefits and drawbacks. Consult your professional advisers for guidance tailored to your specific circumstances.

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