What is the right business structure for me?

I get this question a lot. The following post will explain the different choices available to you and the pro and cons. It is a good starting point.

Four Basic Forms

• C Corporation (and PSC or Professional Service Corporation)
• S Corporation
• General Partnership
• Limited Partnership

Recently Developed Alternatives

• LLC (Limited Liability Corporation)
• LLP (Limited Liability Partnership)
• LLLP (Limited Liability Limited Partnership)
• And the very basic form, Sole Proprietorship
  
  Two Most Important Factors

• Tax rates imposed on enterprise’s income and appreciation (after factoring double taxation)
• The investor’s potential personal liability for the enterprise’s obligations and actions. Note that owners and officers are liable for fraud and taxes regardless of the business form.

Three Fundamental Questions

•  First – Will the enterprise benefit from the double tax that might occur using a C corporation or from the one time pass-through tax offered by non-C corporation alternatives.
• Second – If a pass-through entity is preferred, would the enterprise benefit more from the use of the S corporation or the partnership taxation rules.
• Third – If the partnership rules are preferred, which business form is most suitable: general partnership, limited partnership, LLC, LLP or LLLP.

Tax advantages of an S corporation over a C corporation for closely held Corporations

• Single Taxation – taxable income is passed to the owners. Note that C corporations use tax planning to avoid double taxation, which includes bonus and salary distributions to eliminate taxable income at the corporate level.
• No accumulated earnings taxes.
• Losses pass though to shareholders subject to the passive loss and at risk rules.
• Accrual Method of Accounting - C corporations must use the accrual rules when gross receipts exceed $5,000,000, while S corporations do not.

Tax advantage of a C corporation over an S corporation

• C Corporation - Tax rate is 34% up to $10,000,000
•  Individuals – Top tax rate is 39.6%
• Alternative Minimum Tax – AMT is determined at the shareholder level for S corporations and at the corporate level for C corporations. Currently the corporate AMT rate is 20% while the individual rate can be as high as 28% if AMT exceeds $175,000. An AMT credit for individuals does not allow a credit for exclusion preference items, while a C corporations generates AMT credit against regular tax for all items causing AMT. C corporations with average gross receipts less than $5,000,000 for the first test year and $7,500,000 or less in subsequent years are totally exempt from AMT.
• Fringe Benefits – partners in S corporations with more than a 2% ownership are treated as partners in partnerships for fringe benefit purposes.

Partnership versus S Corporation Taxation

Background

In a partnership, general partners are liable for partnership liabilities while limited partners have limited liability. Also, in many states, the limited partners cannot participate in the partnership’s business operations and retain limited liability. A Limited Liability Company (“LLC”), with proper planning, will be taxed as a partnership while giving the owners limited liability similar to corporate stockholders. Moreover, unlike limited partners, LLC owners can materially participate in the LLC business activities without incurring personal liability.

General Information

LLCs and are created by statutes. The LLC’s principal competitor for choice of a business entity for small businesses is the S corporation. This is because both entities are the only entities that offer all of the following:

• Pass-through tax treatment to all owners
• Limited liability to all owners
• Material participation by all owners without losing limited liability

          However, following are tax differences between a partnership and an LLC (taxed as a partnership):

• Formation. Tax-free formation of an S Corporation requires the stockholders to satisfy an 80% control test, and the stockholder’s must avoid gain by excess debt under f357(c), while an “LLC” has no control requirement upon formation and it is much less likely that a contributing member will trigger gain from excess debt upon formation.
• Capital Structure. An LLC can allocate cash flow in the same flexible manner as a partnership, while S corporations’ single class of stock requirement prohibits any non-pro rata allocation except by salaries for services performed.
• Income Allocation. An LLC can allocate income, gain, loss, and deductions as agreed to by the partners so long as the allocations have ‘substantial economic effect.” S corporation income and losses must be allocated pro rata based strictly on stock ownership.

Limited Liability Partnerships (LLP)

An LLP is a registered partnership that offers partners liability protection from malpractice, errors, and omissions of the other partners, but not from commercial or contract liability of the partnership.

Although LLPs offer less liability protection than LLCs, professional organizations that have multi-state practices opt for this business entity form because some states prohibit “professionals” from operating as LLCs and many states require that all members of a LLC be members of the same profession.

Limited Liability Limited Partnerships (LLLP)

An LLLP is a registered partnership that offers general partners liability protection from malpractice, errors, and omissions of the other general partners, but not from commercial or contract liability of the partnership.

Sole Proprietorship

There are no requirements to form a sole proprietorship. Taxable income of the business is the taxable income of the Sole Proprietor. There is no liability protection. If there are no employees, there is no payroll reporting. A tax deduction of up to 60% of health plan benefits is available.

DISCLAIMER
THIS SUMMARY IS DESIGNED AS A GUIDE TO UNDERSTANDING OF THE VARIOUS RETIREMENT PLANS AVAIABLE AND THEIR TAX BENEFITS AND CONSEQUENCES. THIS SUMMARY IS NOT INTENDED TO PROVIDE LEGAL, ACCOUNTING OR OTHER PROFESSIONAL SERVICES.