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Thursday, October 27, 2011

BASIC ADVANTAGES AND DISADVANTAGES OF BUSINESS ENTITIES

1. Sole Proprietorship

a. Advantages:

(1) No organizational formalities.

(2) Decision making is informal and owner has sole authority, subject to any delegation to agents.

(3) No qualification requirements for doing business in other states.

(4) Minimal reporting to governmental entities.

(5) Business profits are subject to only one tax, at the individual level, and are not subject to double tax as would be the case if the profits were realized by a C corporation.

(6) Losses are available on the owner’s personal income tax return and can offset other income (subject to the passive loss rules).

b. Disadvantages:

(1) Owner has unlimited liability for obligations and liabilities of the business.

(2) Death or disability of owner terminates business.

(3) Sale or other transfer of business requires transfer of individual assets.

(4) No opportunity to utilize equity capital contributed by persons other than the owner.

(5) Business profits are taxed as income to the owner and, as a result, are subject to self-employment tax as well as income tax.

2. General Partnership

a. Advantages:

(1) Multiple owners can provide a combination of individual resources and talents.

(2) Minimal formalities are required for organization.

(3) Decision-making may be informal, although partnership agreement is generally used to establish procedures for making decisions.

(4) No qualification requirements for doing business in other states.

(5) Minimal reporting to governmental entities.

(6) Business profits are subject to only one tax, at the individual partner level, and are not subject to double tax as would be the case if the profits were realized by a C corporation.

(7) Losses are available on the partners’ personal income tax returns and can offset other income (subject to the passive loss rules).

(8) Special allocations may be made for income tax purposes.

(9) Disproportionate distributions may be made to partners.

b. Disadvantages:

(1) Partners have unlimited liability for obligations and liabilities of the business.

(2) Death, disability, or withdrawal of a partner may terminate partnership, although this can usually be handled by appropriate provisions in partnership agreement.

(3) All partners have the right to participate in management.

(4) All partners have broad authority to act on behalf of, and incur debts and liabilities for, the partnership.

(5) Business profits are taxed as income to the individual partners and, as a result, may be subject to self-employment tax as well as income tax.

3. Limited Partnership

a. Advantages:

(1) Limited partners enjoy limited liability.

(2) Only general partners participate in management so that limited partners can be equity owners without the general partners giving up control.

(3) There are no limitations on the number or types of partners.

(4) Existence is unaffected by the death or transfer of interest by a limited partner.

(5) Business profits are subject to only one tax, at the individual partner level, and are not subject to double tax as would be the case if the profits were realized by a C corporation.

(6) Losses are available on the partners’ personal income tax returns and can offset other income (subject to the “at risk” and passive loss rules).

(7) Special allocations may be made for income tax purposes.

(8) Disproportionate distributions may be made to partners.

b. Disadvantages:

(1) Formalities are required for organization.

(2) Qualification is required for doing business in other states.

(3) Regular reporting to governmental entities is required.

(4) General partners have unlimited liability for obligations and liabilities of the business.

(5) Death, disability, or withdrawal of a general partner may terminate partnership.

(6) Limited partners have limited ability to participate in management or decision making.

(7) Business profits are taxed as income to the individual partners and, as a result, may be subject to self-employment tax as well as income tax to the extent they are allocated to general partners.

(8) Transfer of interests may be subject to securities law regulation.

4. Limited Liability Company

a. Advantages:

(1) All members enjoy limited liability.

(2) No limitation on the number or types of members.

(3) Centralized management is available if an LLC is manager managed.

(4) Assuming LLC is taxed as a partnership (see above), business profits are subject to only one tax, at the individual member level, and are not subject to double tax as would be the case if the profits were realized by a C corporation.

(5) Losses are available on the members’ personal income tax returns and can offset other income (subject to the “at risk” and passive loss rules).

(6) Special allocations may be made for income tax purposes.

(7) Disproportionate distributions may be made to members.

b. Disadvantages:

(1) Formalities are required for organization and operation.

(2) Qualification is required for doing business in other states.

(3) Regular reporting to governmental entities is required.

(4) Termination results from the death, disability, or withdrawal of a member under the laws of some states.

(5) Interests are not freely transferable.

(6) Business profits are taxed as income to the individual members and, as a result, may be subject to self-employment tax as well as income tax.

(7) Transfer of interests may be subject to securities law regulation.

5. C Corporation

a. Advantages:

(1) All shareholders enjoy limited liability.

(2) Ownership interests are freely transferable.

(3) Perpetual existence unaffected by the death of shareholders or transfer of shares.

(4) Centralized management.

(5) No limitation on the number or types of shareholders.

(6) Flexibility of financing is available through the sale of various types of securities to many investors.

(7) Tax-favored fringe benefits are available to employee-shareholders.

(8) Income is taxable at corporate rates, which are for the most part for the most part lower than individual rates.

b. Disadvantages:

(1) Formalities are required for organization and operation.

(2) Qualification is required for doing business in other states.

(3) Regular reporting to governmental entities is required.

(4) Income is subject to double taxation.

(5) Losses of business may not be deducted by individual shareholders.

(6) The distribution of property by a C corporation to its shareholders is generally a taxable event for income tax purposes as to both the corporation and the shareholders. Thus, withdrawing property from a corporation can be extremely expensive from a tax standpoint.

6. S Corporation

a. Advantages:

(1) All shareholders enjoy limited liability.

(2) Ownership interests are freely transferable (subject to restrictions imposed by contract to preserve S corporation status).

(3) Perpetual existence unaffected by the death of shareholders or transfer of shares.

(4) Centralized management.

(5) Business profits are subject to only one tax, at the individual shareholder level, and are not subject to double tax as would be the case if the profits were realized by a C corporation.

(6) Losses are available on the shareholders’ personal income tax returns and can offset other income (subject to the “at risk” and passive loss rules).

b. Disadvantages:

(1) Formalities are required for organization and operation.

(2) Qualification is required for doing business in other states.

(3) Regular reporting to governmental entities is required.

(4) Strict qualification rules must be met on a continuing basis, which among other things limit the number and types of shareholders.

(5) The distribution of property by an S corporation to its shareholders is generally a taxable event for income tax purposes.

FOR MORE INFORMATION OR TO CONTACT A SMALL BUSINESS LAWYER CALL RAXTER LAW
 at (951) 226-5294
Local Small Business Lawyer

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