The Best Form of Doing Business

The Best Form of Doing Business

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In the great majority of cases, we recommend that our small business clients do business either as an “S” Corporation or a Limited Liability Company because these two forms avoid double taxation and limit the personal liability of owners.

There are occasions, however, when a C Corporation or Partnership form of doing business is appropriate.

We generally advise our clients not to operate their businesses as a Sole Proprietorship.

This article discusses the advantages and disadvantages of the various forms of doing business:

Sole Proprietor

This form of doing business is really no form at all.

You don’t incorporate, form a partnership or establish a limited liability company, but, rather, you run your business in your own name.

Sole proprietors are required to annually report their business income and business expenses on a Schedules “C” that is included with their Forms 1040.

Advantages

Least expensive form of doing business

File only one tax return

Disadvantages

Greater chance of IRS Audit

Imposition of 15.3% Self-Employment tax on ALL Net Income of Business

Owner is liable for all business debts and liabilities

Difficult to transfer ownership interests

Corporation

A corporation is a separate legal entity requiring its own employer identification number (tax ID #) and the filing of a separate annual tax return.

There are two types of corporations;

The “C” Corporation

Any corporation that does not make an election to be treated as an “S” corporation is a “C” corporation.

C Corporations pay tax on the net income reported on their Form 1120, annual income tax return.

Any distributions made to shareholders (other than wages) are not deductible by the corporation and are includible in the shareholders’ taxable income.

Advantages

Liability for corporate debts limited to corporate assets (creditors cannot sue shareholders for corporate debts)

Corporations are less likely than sole propreitorships to be selected for Audit

Easy transferability of ownership interests

Disadvantages

C Corporations must file a separate annual tax return

Corporations must maintain a corporate records book and separate accounting records

Distributions to owners may result in “double taxation.”

The “S” Corporation

Certain small businesses may make an election to be treated as an S corporation

S corporations report their income and expenses on Form 1120S.

An S Corporation does not pay taxes on its net income. Instead, each shareholder includes his or her share of corporate net income on his or her individual tax return.

For this reason, an S Corporation is known as a “pass-through entity.”

Advantages

Liability is limited to corporate assets

Less likely (than sole proprietorship) to be selected for audit

Easy transferability of ownership assets

Avoid double taxation

Some net income not subject to employment tax (save 15.3% on such income)

Disadvantages

Must file separate annual tax return

Must maintain corporate records book and separate accounting records

Shareholders must report share of net income or loss of corporation based on their percentage ownership of outstanding shares (cannot assign interests to various shareholders based on tax benefit to that shareholder)

Cannot have foreign resident shareholder

Required to have limited number of shareholders

Limited Liability Company

The Limited Liability Company (LLC) is a relatively recent phenomenon.

LLC’s have members rather than shareholders and are required to report the results of their operations either on a form Schedule C included that is included with the managing member’s Form 1040 or on a Form 1120s.

Advantages

Liability is limited to business assets

Less likely than a sole proprietorship to be selected for audit

Annual record-keeping requirements lessened

Avoid double taxation (compared to C corporation)

Membership interests of LLCs can be assigned, and the economic benefits of those interests can be separated and assigned, providing the assignee with the economic benefits of distributions of profits/losses (like a partnership), without transferring the title to the membership interest

Disadvantages

State LLC laws differ (lack of uniformity)

Generally, all LLC net income is subject to self-employment tax

Partnership

Partnerships are required to report the results of their operations on Form 1065.

Partnerships, like LLCs and S Corporations, are pass-through entities.

Advantages

Lessened state registration requirements

Somewhat less likely than a sole proprietorship to be selected for an IRS Audit

Avoid double taxation

Disadvantages

General partners are jointly and severally liable for all partnership debts

Limited life (partnership terminates with death, incapacity or insolvency of any general partner)

Lack of free transferability of partnership interests

About Peter Pappas

Peter is a tax attorney and certified public acccountant with over 20 years experience helping taxpayers resolve their IRS and state tax problems.

He has represented thousands of taxpayers who have been experiencing difficulty dealing with the Internal Revenue Service or State tax officials.

He is a member of the American Association of Attorney-Certified Public Accountants, the Florida Bar Association and The Florida Institute of Certified Public Accountants and is admitted to practice before the United States Tax Court, the United States Supreme Court, U.S. District Courts - Middle District of Florida