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  • Rafael Valentin

Most common forms of business entities, and the pros and cons of each!

A question that I receive often is "When should I incorporate my business and what business entity should I utilize?" This question is one that could lead to a variety of discussions and should not be taken lightly as you, a business owner, can have severe legal and tax obligations arise as a result of the form of business you decide to employ. The aim of this post is to answer general questions about each business form.

- Sole Proprietorship

In a sole proprietorship, the operations and activities of a business are not considered separate from other activities of the business owner. This form is generally best considered for very small, single-owned start-ups in which there are not any tax concerns.

Pros:

The owner has sole control over the business.

It is simple and inexpensive to create.

It is considered a "pass-through entity" for tax purposes as the income and deductions from this form of business flow directly to the owner's personal tax return via Schedule C.

Cons:

NO limit for personal liability (this means that creditors could go after the owner's personal assets to satisfy any debts)

Access to capital is limited.

Business activities limited by the owner's performance.

- General Partnership

A general partnership is not separate from its owners and the partners involved are personally liable for the debts of the business. It is best suited for multiple owners, all of which aim to be involved in the operations of the business. A partnership agreement should be created and agreed upon before operations begin.

Pros:

It is simple and inexpensive to create.

This form of business is also considered a "pass-through entity" as the income and deductions from this form of business flow directly to the partner's personal tax returns. Each partner will be issued a Schedule K-1 to reporting his/her share of income and deductions.

Cons:

Partners are personally liable for the debts and lawsuits of the business, including those arising from the actions of other partners.

It is difficult to remove or change partners without dissolving the partnership absent a provision in the partnership agreement.

- Limited Partnership

A limited partnership has two or more partners in which at least one partner is considered a limited partner and at least one is considered a limited partner. This is best suited when one partner seeks a passive investment with no interest in day-to-day operations and management of the business.

Pros:

It is considered a "pass-through entity" (see general partnership)

*The liability of the limited partner(s) can be limited to the extent of his/her investment (He or she only stands to lose the amount invested in the business and his/her personal assets are not vulnerable).

Cons:

General partners are personally liable for business debts and lawsuits, including those arising from the actions of other partners.

It is difficult to remove or change partners without dissolving the partnership absent a provision in the partnership agreement.

- Limited Liability Company

A limited liability company (L.L.C) exists as a separate legal entity from its owners. It is best suited for single or multiple owners that seek single-level taxation and protection from unlimited liability.

Pros:

Liability is limited to the extent of the owner's investment in the business (personal assets of the owner are not vulnerable to debts and lawsuits).

Capital can be raised through the sale of company interest.

L.L.C's are considered "pass-through entities", but also have the choice to be taxed as an S Corporation by filing Form 2553.

Cons:

It can be difficult to raise capital.

- C Corporation

Corporations are owned by shareholders. The number of shareholders of a C corporation can be unlimited. This entity form is best suited for large, multiple-owner businesses seeking both limited liability and established procedures for management and funding.

Pros:

There is limited owner liability concerning debts and lawsuits.

Capital can be raised easily through the sale of stock.

Cons:

Many formalities and complexities concerning the creation of a corporation.

Shareholders are exposed to double taxation.

- Non-Profit, also known as Not-For-Profit

A non-profit organization is a company that does not exist for the purpose of earning a profit but for a public purpose (i.e religious, charitable, educational, artistic, scientific, etc.). All income and profit of a non-profit is dedicated to the purpose of its existence.

Pros:

Non-profits do not pay income taxes.

Donations made to 501(c)(3) organizations are tax-deductible for the donor.

Cons:

Any profit earned must be applied to the operation of the organization and can not be distributed to its members, officers or directors.

Non-profits may be expensive and are difficult to create.



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