A principal consideration for any new or existing business is choosing an appropriate legal entity. Available options in most states include C corporations, S corporations, general and limited partnerships, limited liability companies (LLCs), limited liability partnerships (LLPs) and sole proprietorships.
Income tax implications of your entity choice
Each entity type has advantages and disadvantages. It’s important to consider the tax implications. A certain type of entity can minimize your taxes. Understanding the total tax situation, including income tax, payroll tax, and estate tax exposure, is essential when determining the choice of entity.
Personal liability protection is often an owner’s main objective in choosing the appropriate entity. Operating as a proprietorship or general partnership offers no owner liability limitation. Limited partnerships, LLCs, LLPs, S corporations, and C corporations provide varying degrees of liability protection for the owners, depending on state law. For sole owners, the single-member LLC is a popular liability-limiting alternative to a proprietorship.
If a business is owned by more than one individual, it cannot be run as a proprietorship. If all owners provide management services, a limited partnership is not a viable option, because that would jeopardize their status as limited partners. Limited partnerships, LLPs, LLCs, C corporations, and S corporations allow for management by multiple individuals without limitations.
Get ready for business succession
In many cases, an entity status change is sought to accomplish a transition in ownership. Whether the objective involves moving ownership to a successor via gifts, an installment sale, a stock redemption, a bequest, or a combination of methods, it may be beneficial to use a different form of entity to meet these objectives. Each entity selection situation is unique. The business owner’s objectives must be systematically matched with the various entities’ attributes. All major tax and nontax issues must be considered and alternatives explored before choosing the appropriate structure for your business.
As with most business decisions, planning can have a positive, lasting effect on your venture. Contact your tax adviser with questions about the appropriate entity structure for your existing business, a business you intend to purchase, or a contemplated new start-up business.