Plan for the Future - Call Today! 785.859.4612
Pros and Cons of Business Entities

Pros and Cons of Business Entities

Advantages and Disadvantages of Sole Proprietorships

A sole proprietorship is a business owned by a single individual. There is no formal separation of the business assets and operations apart from the individual. The greatest advantage of the sole proprietorship is its ease of start-up. You, as proprietor, simply begin doing business. It is less expensive to establish a sole proprietorship since no formal documentation is required. You do not have to pay yourself a salary, but can simply make withdrawals from your business account as needed. A sole proprietorship also does not require any formalities such as formal meetings, or records of officers’ or directors’ decisions. There is no need to obtain an employer identification number (EIN) unless there are employees, or unless you are obligated to remit sales tax for products sold. Also, if the business is operated under an assumed or trade name, you may be required to register that name with the state.

The disadvantages of operating as a sole proprietorship include the inability to take advantage of certain tax deductions that are available to other business entities, as well as unlimited liability for the owner. A sole proprietor is personally liable for any damages that are incurred in the course of running that business, and all of the owner’s assets are at risk – whether inside the business or out. This is a huge drawback, even if the business appears to be free of any liability risk. Even a business as mundane as house cleaning or dog walking can generate huge liability problems for the owner if the business is operated as a sole proprietorship. In summary, sole proprietorships offer no asset protection, few planning options, and few good exit strategies.

Advantages and Disadvantages of Partnerships

A partnership is an association of two or more persons to carry on as co-owners of a business for profit.

A general partnership is formed when two or more parties enter into an agreement to conduct a business for profit or mutual benefit. That agreement may be written or oral, formal or informal. Since all general partners will have a direct involvement in the operations of the business, each of the general partners will also be held liable for the debts and obligations of the partnership. In fact, the partners are liable for the acts of their fellow partners who conduct business. This shared liability is a serious disadvantage to forming this type of business entity. It is the primary reason that, for many advisors, the general partnership has limited appeal as a business structure.

A limited partnership is a creature of state law, and generally requires at least one limited partner and one general partner. The general partner has unlimited liability for partnership debts, similar to the sole proprietor or partner in a general partnership. The limited partner has limited liability, limited to their investment in the partnership. This type of business arrangement makes sense if there are active partners who carry out the business, and passive partners who invest in the business but do not have any day to day responsibilities. Usually, in order to provide liability protection for the general partner, the general partner of a limited partnership will actually be an entity that has limited liability, such as a corporation or limited liability company.

Both forms of partnership are pass-through entities for purposes of taxation. The partnership does not pay federal income tax at the partnership level. Instead, the partners report the income or loss on their individual tax returns. Interests in most partnerships, and especially limited partnerships, are not easily transferred. Many limited partnerships limit the transferability of limited partnership interests in the written partnership agreement.

Advantages and Disadvantages of Corporations

Corporations are formed and governed under state law. Generally, state law requires corporate formalities to be followed in order for the corporation to be treated as a separate entity from the owners. A C corporation is a corporation whose income is taxable, by both federal and state governments, at the corporate tax rate. As a result, a C corporation is subject to “double taxation” because the corporation pays its own tax on its income and, when the earnings of a corporation are distributed to shareholders, it is taxed a second time as a dividend.

An S corporation is not taxed as a separate taxable entity. The corporation’s income or loss passes through to the corporation’s shareholders without being taxed to the corporation. This is similar to taxation for partnerships. The shareholders report their share of the income on their personal income tax returns. S corporations have limits on who may become a shareholder.

A “closely-held corporation” is a corporation owned by just a few people as opposed to a public corporation whose stock can be purchased by the public on one of the stock exchanges.

Corporations also benefit from an unlimited lifespan. The corporation is not affected by the death or bankruptcy of a shareholder, unlike general partnerships or sole proprietorships. Of all the benefits of doing business as a corporation, the single most important benefit is limited liability for the shareholders. Assuming that all corporate formalities are followed (which is not too difficult to accomplish), shareholders will not be liable for business debts.

Advantages and Disadvantages of Limited Liability Companies (LLCs)

Limited liability companies are a product of state law. Although a much newer form of business entity than corporations, they are available in all states. In many cases the LLC may be a better choice than a corporation. In fact, a limited liability company combines the best attributes of a corporation, such as limited liability for members, with pass-through taxation, similar to a partnership. An LLC is owned by members, and can be managed either by the members or by a manager who is elected by the members. LLC members can be individuals or any other type of entity, including trusts. Also, non-resident aliens can be members, unlike shareholders of an S Corporation. This affords an LLC great flexibility in ownership and structure.

A key benefit of an LLC is the ability to choose how that entity will be taxed. An LLC can elect to be taxed as a C corporation, an S corporation, or a partnership, and can even be disregarded for tax purposes in some states – making it similar to a sole proprietorship for taxation purposes.

Categories:

Contact Us Today!

    • Please enter your name.
    • Please enter your name.
    • Please enter your email address.
      This isn't a valid email address.
    • Please make a selection.
    • Please enter a message.