When you understand how a business is designated, or the type of incorporation, it can clue you in to how the company operates. Most companies are required to incorporate their business in the state in which they are headquartered or where they conduct the majority of their business. States handle a variety of business designations.
For federal tax purposes, however, there are six important types of business entities:
1. Sole Proprietor – These are unincorporated businesses — the independent contracts and freelancers of the world. You don't need to fill out any forms to start this type of business, only report your business income for tax purposes. A sole proprietorship is the easiest type of business to set up and dissolve.
2. C-Corporation – Incorporated businesses. For-profit entities with at least one shareholder, which has full discretion over the amount of profits it distributes or retains.
3. S-Corporation- Closely held corporations. The corporation's income and losses are divided among shareholders, who are then individually taxed on their earnings.
4. Partnership – Unincorporated businesses. Partnerships must have at least two partners, one of whom assumes unlimited liability for the business. Net income is distribute to the partners.
5. Trust – most common when formed upon the death of an individual, with the goal of continuing investment activities and distributing assets to a beneficiary.
6. Nonprofit organization – formed for a charitable, religious, or artistic purpose. These corporations are generally tax exempt, but report their earnings and activities to the IRS.