One of the most important decisions new business owners make is choosing the entity type that will be used for the business.
Here's a summary of the advantages and disadvantages of each entity type:
1) Sole proprietorship:
- Advantages:
- Easy to form, simple to operate.
- Easy to sell business assets.
- Few administrative burdens.
- Income is generally passed through to the owner.
- Disadvantages:
- Generally, have limited sources of capital.
- Unlimited liability and no guarantee of continuity.
- Business income is subject to self-employment tax.
2) Partnership:
- Advantages:
- More sources of capital and more resources available than proprietorships.
- Fewer admin burdens than corporations.
- Income and losses are generally passed through to the partners.
- Disadvantages:
- Transfer of interests is more difficult than proprietorships.
- Unlimited liability for partners.
- Net income is subject to self-employment tax.
- Partners are entitled to few tax-free fringe benefits that are generally available to employees.
3) Limited Partnerships:
- Advantages:
- Pass-through partnership taxation status.
- Flexible ownership structure.
- Limited partners are not personally liable for the debts/obligations of the LP if they don’t engage in management.
- Disadvantages:
- Must file with the state to register.
- In most states, general partners are liable for debts/other obligations of the LP.
- Losses for limited partners are generally passive losses.
4) Limited Liability Partnerships:
- Advantages:
- Pass-through partnership taxation status available.
- Flexible ownership structure and partners can insulate themselves from the acts of other partners.
- Disadvantages:
- Required to file with the state.
- Unlimited liability for own acts of malpractice.
5) Family limited partnership:
- Is often used as an estate planning strategy for families above the federal estate tax exemption.
6) Limited Liability company (LLC)
- Advantages:
- Members have limited liability; number of members is unlimited.
- Members can be individuals, corporations, trusts, other LLCs, etc.
- Income is passed through to members.
- Double taxation is avoided if partnership tax status is elected.
- Members can participate in management and there are multiple classes of ownership.
- Distributions to members don’t have to be proportional to the members’ ownership interests as they do for S corporations.
- May elect to be taxed as a partnership, an S corp, or a C corp.
- Disadvantages:
- May have limited life.
- Transfer of interests is difficult and sometimes limited by operating agreement.
- Some industries may not be permitted to use LLC status.
- Laws vary by state and laws are relatively new for LLCs.
- For tax purposes, the partnership rules generally apply.
- Members not meeting exceptions are subject to self-employment tax on all earned income if partnership status is elected.
7) C corporation:
- Advantages:
- Ease of raising capital and generally more management resources.
- Limited liability of shareholders and ease of transfer of ownership interests.
- Unlimited life of entity.
- Individuals may receive all employer-provided tax-free fringe benefits.
- Disadvantages:
- Potential for double taxation due to entity level taxation.
- Administrative burdens.
- More difficult to form and dissolution can cause taxable gains.
- Borrowing may be difficult without stockholder personal guarantees, which negates part of the advantage of limited liability.
- Requires a registered agent and federal tax ID number.
8) S corporations:
- Advantages:
- Income is passed through to the shareholders and shareholder have limited liability.
- Income is taxed at the individual level (may be lower than corporate rate).
- Distributions are exempt from the payroll tax system, assuming the Corp provides adequate compensation to those shareholders who are employees of the Corp.
- Disadvantages:
- Limited to 100 shareholders and only one class of stock.
- Shareholders must be individuals.
- Shareholder employees owning more than 2% of the company must pay taxes on a range of employee fringe benefits that would be tax-free to a shareholder of a C corp.
- The tax rate of a shareholder may be higher than the corporate tax rate.
- Borrowing may be difficult without stockholder personal guarantees.
Together, we can work to keep you on-track toward your financial goals.
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