The legal structure of a business determines the following:
- the way business income or loss is reported to the IRS,
- the taxes that are paid,
- the ability of the business to accumulate capital, and
- the extent of the owner’s liability.
There are five principal business structures: sole proprietorships, partnerships, limited liability companies (LLCs), S corporations, and corporations. Knowledge of the structure of a self-employed borrower’s business will assist the lender in analyzing and evaluating the stability of the business and the degree of the borrower’s involvement.
There are certain legal business structures considered "pass-through entities" for federal income tax purposes. This means these entities are not subject to income tax, rather, the owners are directly taxed individually on the income, taking into account their share of the profits and losses.
For additional information, see B3-3.2-02, Business Structures.