There is a significant importance for tax professionals to be capable of assisting clients and entrepreneurs with the process of choosing the correct business entity structure. There is a greater importance for entrepreneurs to seek assistance or to also understand the advantages and disadvantages of the available business entity structures available as well. Choosing the appropriate business entity structure will not only assist a business in accomplishing their business objectives, but also will determine aspects regarding taxation of income and how their assets will be protected. The most common business entity structures include: Sole Proprietorships, Limited Liability Companies, Partnerships, and Corporations. Understanding the tax advantages and tax disadvantages of the previously mentioned business entity structures may become the difference of operating a successful business and operating an unsuccessful business.
A sole proprietorship is a business owned by one individual whom typically operates the business on a day-to-day basis; there is also no formal legal structure involved with a sole proprietorship. Generally sole proprietorships are an ideal business entity structure for small businesses such as those involving crafts. A couple advantages outlined by include:
An additional business entity structure consists of partnerships; a business with more than one owner who all are actively engaged in the operations while equally sharing, unless specified in a written agreement, in the profits and losses. There are two forms of partnerships that exist consisting of a General Partnership and a Limited Partnership. A general partnership is commonly formed through a verbal agreement and is not required to file a partnership agreement with the state; however, it is highly recommended that partnerships implement a written agreement as quickly as possible. Advantages of a general partnership include:
Limited Liability Company
A limited liability company (LLC) is a hybrid business entity structure that includes the limited liability features similar to what corporations possess while also possessing the tax and operational efficiency and flexibility that partnerships benefit from. The tax flexibility includes the ability to elect a classification, not legal classification, regarding federal income tax purposes as treatment as a partnership, a corporation, as well as a disregarded entity. Additional advantages also include:
Corporations are a unique business entity structure that can consist of one person or a group of individuals incorporated as a separate entity within the state the business is headquartered. The owners of a corporation include the corporations’ shareholders and corporations possess the ability to enter into contracts, get sued, as well as get taxed on their own. Different types of corporations include C – Corporations such as General Motors and Starbucks as well as S – Corporations which is commonly used as a pass-through entity for taxation. Advantages of C – Corporations include:
With the proper planning and research business owners have the flexibility and freedom to elect a business entity structure providing their business with numerous advantages coupled with possible disadvantages. Therefore it is important for tax practitioners to dedicate time and energy with their clients to ensure the proper business entity structure has been implemented.
Adam Carr, MBA, EA