What are the Advantages & Disadvantages of Each Type of Entity

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September 6, 2017
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What are the Advantages & Disadvantages of Each Type of Entity

Each structure has advantages and disadvantages regarding liability protection, tax treatment, and ease of operation.  Keep in mind that the limitation of liability afforded by the structures discussed below applies only to general business liability, not professional liability. Regardless of the structure you chose for your solo practice, you must maintain appropriate malpractice insurance to avoid exposure to professional liability.

What Are the Advantages and Disadvantages of a Sole Proprietorship?

The advantages of a sole proprietorship include:

  • Minimum legal restrictions
  • Easy to form, simple to use
  • Easy to discontinue
  • No corporate formation to conduct or document
  • No additional tax return to file
  • No FICA on wages paid to children under 18
  • No FUTA for children under 21

The disadvantages of a sole proprietorship include:

  • Unlimited personal liability
  • May not bring in new owners without entity change or outside capital contributions
  • Income tax cannot be deferred by retaining profits as with a C Corporation
  • Lack of business continuity—entity ceases when the owner dies

What Are the Advantages and Disadvantages of a Partnership?

The advantages of a partnership include:

  • A combination of the skills and/or financial abilities of several people.
  • Easy to establish, extremely flexible
  • Business usually benefits from partners who have complementary skills
  • Termination of the partnership can generally occur tax free
  • If parents are the only partners—No FICA on wages paid to children under 18 and no FUTA for children under 21
  • IRC 754 – Optional basis adjustment for incoming owners
  • Special Tax Allocations
  • Partner deduction for unreimbursed expenses
  • Debt basis, at-risk and distribution rules make it a great entity to house real estate

The disadvantages of a partnership include:

  • A partnership is often easier to get into than out of
  • General partners are liable for the actions of other partners (unlimited liability)
  • Sharing of profits
  • Disagreements in decision making
  • Flexibility comes with additional responsibility
  • Must track built-in gains

What Are the Advantages and Disadvantages of a C Corporation?

The advantages of a C corporation include:

  • Limited liability
  • Perpetual life
  • Ability to raise capital through the issuance of stock
  • Ease of transfer of ownership

The disadvantages of a C corporation include:

  • Double taxation on profits makes entity unfavorable for appreciating property
  • Lack of availability for marginal tax brackets for professional corporations
  • Corporate charter restricts types of business activities
  • Subject to various state and federal controls
  • Liquidation gains usually trigger significant double taxation
  • Personal Service Corporations (PSCs) are subject to limitations on selection of year end and flat 35% tax rate, making it an unlikely entity choice for professional organizations
  • Personal Holding Company Tax (PHC)
  • Accumulated Earnings Tax

What Are the Advantages and Disadvantages of an S Corporation?

The advantages of an S corporation include:

  • Limited liability and perpetual life
  • Avoids double taxation of profits
  • Profits passed through are not subject to SE tax, FICA or Medicare Taxes, as in a partnership
  • Ability to raise capital by issuing stock

The disadvantages of an S corporation include:

  • Shareholders pay tax on undistributed earnings retained by the S Corporation.
  • Less flexibility in choosing a tax year
  • Contribution limits to a qualified retirement plan are based on employee-shareholder’s wages, not overall profits, such as a sole proprietor or partner
  • Limit on number of shareholders can potentially limit capital infusions
  • More rigid than a partnership, allows for a flow through without the need to track built-in gains
  • Distribution rules not favorable with regard to appreciated property

What Are the Advantages and Disadvantages of a Limited Liability Company (LLC) taxed as a partnership?

The advantages of an LLC include:

  • Avoids certain S corporation restrictions
  • Avoids double taxation of profits
  • Business usually benefits from members who have complimentary skills
  • Disproportionate distributions and allocations of income are possible

The disadvantages of an LLC include:

  • Inconsistent treatment state to state
  • Must have at least two owners to be taxed as a partnership for federal tax purposes
  • Members pay tax on undistributed earnings
  • Disagreements in decision making