What is the best form of business for my company?

Charlene M. Ives, CPA, PC

Charlene M. Ives, CPA, PC

Business owners are often too quick in their decisions regarding the choice of business entity. This choice can have dramatically differing short-term and long-term effects, and choosing the wrong form can hamper an owner's ability to minimize taxes and plan for growth and exit strategy.

In order to make an informed decision, you must first have an understanding of the most basic forms of business. There are several main forms of business:

1. Sole proprietorship

This is the easiest form of business because there are no corporate or formation formalities and no double taxation. However, the primary disadvantage of a sole proprietorship is that the owner is personally liable for the debts and obligations of the business.

2. Corporation

The corporation is a separate entity from its owners, and the owners (stockholders) are not personally liable for the corporation?s debts. There is a corporate tax levied on the net taxable income of the company (creating the potential for double taxation).

On the other hand, the corporation can pay and take tax deductions for fringe benefits paid to owners. Corporations should maintain proper minutes and records of company business, as well as file annual reports to state agencies.

By making the Subchapter S election, the entity-level tax can be eliminated. However, S-Corporations may not take tax deductions paid on behalf of its more than 2% shareholders. Both C corporations and S corporations can transfer ownership freely, but S corporations have stringent requirements as to maintaining a single class of stock (this means that shareholders may not have unequal distribution rights as to income, losses, and liquidations).

3. General Partnerships

A general partnership is an association of two or more person transacting business as co-owners with intent to make a profit. Each partner is personally liable for the debts and obligations of the partnership, and may act with power to bind the partnership. Partners have great flexibility in dividing profits and losses.

4. Limited Liability Company

Though the members of an LLC enjoy the same protection from company liability as that of corporation shareholders, the LLC has the advantage of less formal disclosure and reporting requirements. The LLC members also have great flexibility regarding allocation of income, losses, and liquidation distributions.

Guidelines For choosing a business entity

Here are a few guidelines for your choice of business entity:

For a single owner, the S Corporation is often the best choice, unless there is a serious consideration of fringe benefits.

  • For multiple owners who anticipate equal treatment, the S Corporation is often well advised.
  • For multiple owners who need flexibility in allocations of income and losses, the LLC is almost always best, unless your exit strategy requires a different form of business.
  • For very small businesses, a C corporation can be a good choice because of the benefit of deducting fringe benefits.
  • For growing businesses, the LLC and S Corporation usually yield better tax consequences of liquidation.

There are many considerations regarding the best choice of business entity, and this article is not inclusive. Obtain professional advice before proceeding with this important choice.

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