Selecting the right entity type for your business is never a one size fits all proposal. Entity selection has two main areas of concern, Legal Liability and Tax Ramifications. Since we are not attorneys, I will only focus on the tax portion of the entity comparison.
Most of the below takeaways are applicable no matter what industry you are operating - Dental, Legal, Marketing, Real Estate, Staffing, etc.
Sole Proprietorship – This form of entity is the simplest to create since there is no distinction between the individual and the business. If a person wants to start a business all they need to do is get the proper business license and “hang their shingle”.
· Ease of formation, no separate return to file.
· No distinction between business assets and personal assets.
· 100% of income is subject to self-employment taxes.
· Very limited tax planning
· No ability to add owners
Partnership - This form of entity is must have 2 or more partners and is governed by the formal partnership agreement. If no formal agreement is created a defacto general partnership is deemed to exist.
· No restrictions on who can be a partner.
· Partnership can be customized by tailoring the agreement.
· Partner can get debt basis to allow losses to be taken in current year.
· Partners can easily be added and removed
· Active partner’s income is 100% self-employment income.
· Partners must receive Guaranteed Payments instead of W-2 (This distinction seems to confuse a lot of people.)
Corporation – There are two main types of corporations C-Corps and S-Corps
· Complete separation from its shareholders.
· Employee benefits availability
· Raising capital by issuing stock
· Not subject to Self-Employment taxes
· Double Taxation
· PSC classification – taxes first dollar at highest rate
· Taking cash out of business a taxable event
· Limits Self Employment Tax exposure
· Pass through income
· Limitations on who can own stock
· Distributions and other allocation must be in accordance to ownership %
· Unusual reporting requirements regarding benefits
If you noticed, I did not mention LLCs at all. That is because an LLC is a Legal entity not a tax entity. A LLC depending on circumstances can fit into every one of the classifications listed above.
In determining which entity structure is right for you, there are many variables that need to be considered before making a decision that will affect how you conduct business. Contact us and let us help you make the decision that is right for you.
This blog article is not intended to be the rendering of legal, accounting, tax advice or other professional services. Articles are based on current or proposed tax rules at the time they are written and older posts are not updated for tax rule changes. We expressly disclaim all liability in regard to actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided in this website is not all inclusive and such information should not be relied upon as being all inclusive.