One of the first and important decisions new business owners face is selecting the right legal structure for their business. Your choice impacts taxes, liability, and how you manage and grow your company. Below is a summary of the most common entity types and their key advantages and disadvantages:
1. Sole Proprietorship
Advantages:
- Simple and inexpensive to form.
- Minimal administrative requirements.
- Income passes directly to the owner.
- Easy to sell business assets.
Disadvantages:
- Unlimited personal liability.
- Limited access to capital.
- Business income subject to self-employment tax.
- No guarantee of continuity.
2. Partnership
Advantages:
- More resources and capital than a sole proprietorship.
- Fewer administrative burdens than corporations.
- Income and losses pass through to partners.
Disadvantages:
- Difficult to transfer ownership interests.
- Unlimited liability for partners.
- Income subject to self-employment tax.
- Limited tax-free fringe benefits.
3. Limited Partnership (LP)
Advantages:
- Pass-through taxation.
- Flexible ownership structure.
- Limited partners have liability protection if not involved in management.
Disadvantages:
- Must register with the state.
- General partners remain fully liable.
- Losses for limited partners are generally passive.
4. Limited Liability Partnership (LLP)
Advantages:
- Pass-through taxation.
- Partners insulated from other partners’ actions.
Disadvantages:
- State registration required.
- Unlimited liability for personal malpractice.
5. Family Limited Partnership (FLP)
- Commonly used for estate planning for families exceeding the federal estate tax exemption.
6. Limited Liability Company (LLC)
Advantages:
- Members have limited liability.
- Flexible ownership and management structure.
- Pass-through taxation (avoids double taxation).
- Can elect to be taxed as partnership, S corp, or C corp.
Disadvantages:
- Limited life in some states.
- Transfer of interests can be restricted.
- Laws vary by state and are relatively new.
- Members may owe self-employment tax if taxed as a partnership.
7. C Corporation
Advantages:
- Easier to raise capital.
- Limited liability for shareholders.
- Unlimited life.
- Access to tax-free fringe benefits.
Disadvantages:
- Double taxation (corporate and shareholder level).
- Higher administrative burden.
- More complex formation and dissolution.
8. S Corporation
Advantages:
- Pass-through taxation.
- Limited liability for shareholders.
- Distributions exempt from payroll tax (with adequate compensation).
Disadvantages:
- Limited to 100 shareholders and one class of stock.
- Shareholders must be individuals.
- Certain fringe benefits taxable to shareholder-employees.
- Borrowing may require personal guarantees.
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