1. Business Entity Classifications
What Am I?
Why?

2. Entity Descriptions
A Sole Proprietorship consists of one individual who carries on an unincorporated trade or business
A Partnership is an organization of two or more owners that functions as a trade or business

3. Entity Descriptions
A C-Corporation is a business entity that carries its own legal status, separate from its owners
A corporation can make an election to be taxed as an S-Corporation by filing Form Only domestic corporations with one share of stock are eligible. An S-corporation is limited to 100 shareholders, and may not have another corporation as a shareholder

4. Entity Descriptions
A Limited Liability Company (LLC) is a liability limiting entity formed under state law. It is considered a Disregarded Entity by IRS, meaning it is treated as a sole proprietorship if there is one owner, a partnership if there are multiple owners, or an election can be made to be treated as a Corporation (Form 2553 must then be filed to be treated as an S-Corporation)

5. Taxation & IRS Forms
Sole proprietors file Schedule C, which reports their net profit or loss and is part of the owner’s Form 1040.
Partnerships file Form The net profit or loss then flows through to the partners via a Schedule K1 according to their reportable share. The partners then report the income on their returns, whether the income is distributed or not.

6. Taxation & IRS Forms
C-Corporations file Form A C-Corporation pays tax on its profits. A distribution of profits to shareholders is called a dividend, which can be taxable. This is why C-Corporation profits are often considered to be “double taxed”. Qualified personal corporations (such as law firms or accounting firms) are taxed at a flat rate of 35%.

7. Taxation & IRS Forms
S-corporations file Form 1120S. Its profits or losses generally (except in rare situations) flow through to the shareholders via Schedule K1. The profit or loss flows through pro-rata based on ownership percentage. Income is taxed at the shareholder level whether it is distributed out or not.

8. How are owners paid and taxed?
Owners of sole proprietorships can take draws from the business without withholding taxes being taken out for federal, state, or FICA taxes. This is because the owner’s income is taxed through the Form In addition to federal and state income tax, Self-Employment Tax of 15.3% is assessed and paid through the A portion of the Self-Employment tax is deductible on page 1 of the 1040.

9. How are owners paid and taxed?
A general partner in a partnership is compensated using Guaranteed Payments. These payments are not subject to federal, state or FICA taxes, however they flow through to the partner and are taxed, with Self-Employment Tax (for individuals) at the partner level. In addition, a general partner’s share of profits are subject to SE Tax (or losses can reduce SE Tax) as well as federal and state.

10. How are owners paid and taxed?
C-Corporation shareholders who perform services, including officers, receive wages subject to federal, state and FICA taxes. Dividend distributions can be taxable for federal and state purposes (but not SE Tax), however they are not deductible for the corporation.

11. How are owners paid and taxed?
S-Corporation shareholder-employees receive wages for services rendered. These must be considered “reasonable”. These wages are subject to federal, state, and FICA withholding taxes. Additional profits are passed through to the shareholder and are taxable for federal and state purposes, but not SE Tax. These profits may be distributed to the shareholders on a pro-rata basis.

12. Tax Treatment of Losses
Business of a sole proprietorship can off set other income, such as interest, capital gains, or wages. Certain circumstances, such as hobby loss rules, can limit the deductibility of the losses.

13. Tax Treatment of Losses
Losses from partnerships flow through to the partners. Recognition of the loss by a partner can be limited by the partner’s “basis” (investment net of previous losses), or passive activity rules (limiting losses of limited partners, or rental losses)

14. Tax Treatment of Losses
Losses of a C-Corporation can be carried back or forward against corporate income of other years, but are not passed through to the shareholders. Capital losses in a C-Corporation are allowed only to the extent of capital gains, otherwise they are carried forward.

15. Tax Treatment of Losses
Losses of an S-Corporation flow through to shareholders pro-rata. Recognition of any loss is limited to the shareholder’s basis.

16. Personal Liability
Sole Proprietors are liable for all business debts and actions
General Partners are personally liable for all partnership debt. Limited Partners are generally liable to their investment in the business

17. Personal Liability
Shareholders of either C-Corporations or S-Corporations are generally not liable for debts incurred by the corporation. Their liability is generally limited to the amount invested.

18. Personal Liability
LLC members are generally not personally liable for the obligations of the LLC (regardless of how the LLC is taxed).

19. Organization and Administration
A Sole Proprietorship is the easiest business to organize as it does not have a legal existence that is separate from its owner. No entity is required to be formed under state law. A fictitious name registration (or DBA registration) may be required in some states if the business is not operated under the owner’s name

20. Organization and Administration
A General Partnership should, but is not required to have, a written partnership agreement. This agreement dictates how income & losses are allocated to partners. If a partnership agreement does not exist, income & loss is allocated based on ownership percentages.
Limited Partnerships require formation documents with the state and comply with state law to maintain limited liability for limited partners

21. Organization and Administration
A Corporation (C or S) must be formed under state law. It has its own legal existence. Corporations must hold periodic board meetings and keep minutes. Corporations must comply with federal and state regulations. Failure to do so can cause the “corporate shield” to be pierced and shareholders to be personally liable for corporate obligations.

22. Organization and Administration
An S-Corporation must make a timely filing of Form 2553 (75 days from the beginning of its tax year, so March 15 would be retroactive to January 1). S-Corporation status is dependent on how may and what type of shareholders are involved. Certain events, such as including ineligible shareholders, can cause automatic termination of S-Corporation status.

23. Organization and Administration
LLC’s are organized under state law with Articles of Organization. Certain state regulations are required to maintain LLC status.
An Operating Agreement is recommended for specifying the rights and obligations of LLC members (even single member LLC’s taxed as Sole Proprietors).

24. Accounting & Bookkeeping
Sole Proprietorships must use a consistent system that clearly reflects income & expenses to allow the taxpayer to prepare an accurate tax return. A balance sheet is not required.
The Sole Proprietorship muse use the same fiscal tax year as the owner (generally December 31)

25. Accounting & Bookkeeping
A Partnership may be required to include a balance sheet with its tax return, depending on the amount of assets or revenue in the business, so double entry bookkeeping is recommended.
Generally a Partnership will have a calendar year end.

26. Accounting & Bookkeeping
A Corporation (C or S) must keep a double entry bookkeeping system, and the balance sheet on a corporation’s books must match the tax return.
Accrual basis balance sheet & income statements may be required in some instances, depending on items such as inventory and amount of revenue generated.

27. Accounting & Bookkeeping
A C-Corporation may elect any fiscal year end it wishes (although it is limited as to how it can change the fiscal year end).
An S-Corporation generally is required to have a calendar year end
An S-Corporation should track the tax “basis” for each of its shareholders so they can determine the amount of losses they can use.

28. Owner Control & Flexibility
In a Sole Proprietorship, the owner is free to make all business decisions.
In a Partnership, control of business operations is divided among all General Partners (all partners in a General Partnership, only the General Partners in a Limited Partnership)

29. Owner Control & Flexibility
In a Corporation (C or S), shareholders have control over the corporation to the percentage they have voting stock.
In an LLC, control is divided among the LLC members.

30. Transfer of Ownership
Because a Sole Proprietorship is not a separate entity from its owner, the “sale” of a sole proprietorship is actually the sale of the business’ assets.

31. Transfer of Ownership
A Partnership interest may be sold, however the partnership agreement may limit restrict the sale of the partnership interest and may control the terms of the sale.
If a Partner buys the partnership interests of all remaining partners, there is no longer a Partnership. (This can cause tax complications)

32. Transfer of Ownership
Corporate Stock Ownership (C or S) is more easily transferred by selling shares of stock. The corporate charter may place certain restrictions on the sale of stock.
S-Corporations need to be careful that stock sales are made between eligible shareholders so the S-Corporation status is not lost.

33. Transfer of Ownership
LLC members can sell or transfer membership units however the operating agreement may restrict the transfer.

34. Advantages of a Sole Proprietorship
Minimal legal restrictions
Easy to form
Easy to discontinue
No Articles of Incorporation or Organization needed to conduct business & document
No additional tax return to file

35. Disadvantages of a Sole Proprietorship
Unlimited liability
May not bring in new owners or outside capital contributions
Income tax cannot be deferred by retaining profits
Lack of business continuity-entity ceases when the owner dies

36. Advantages of a Partnership
Combines the skills and/or financial abilities of several people
Easy to establish
Terminations can generally occur without taxation

37. Disadvantages of a Partnership
General partners are liable for the actions of other partners-unlimited liability
Sharing of profits
Disagreements in decision making

38. Advantages of a C-Corporation
Limited liability
Perpetual life
Ability to raise capital through stock issuance
Ease of transfer of ownership

39. Disadvantages of a C-Corporation
Potential double taxation of profits
Liquidation gains often trigger significant double taxation
Lack of availability of marginal tax brackets for professional corporations
Corporate charter can restrict types of business activities
Subject to various federal and state controls

40. Advantages of S-Corporations
Limited liability and perpetual life
Avoids double taxation of profits
Profits passed through are not subject to Self Employment Tax
Ability to raise capital by issuing stock

41. Disadvantages of an S-Corporation
Shareholders pay tax on undistributed earnings
Less flexibility in choosing a tax year
Contribution limits to a qualified retirement plan are based on employee-shareholder wages, not overall profits such as a sole proprietor or partner
Limit on shareholders can potentially limit capital infusions

42. Advantages to LLC’s
Limited liability of members regardless of tax entity
Ability to change tax entity without changing company name or legal status

43. Disadvantages to LLC’s
Inconsistent treatment from state to state

44. Tax Planning Opportunities
CONSULT YOUR TAX ADVISOR REGARDING HOW ANY OF THESE STRATEGIES APPLY TO YOU
Minimizing Fica/Self-employment taxes (Social Security) through proper entity choice
Sole Proprietorship profits vs losses
Partnership profits vs losses & the effect of Guaranteed Payments
S Corporation wages vs distributions
C Corporation wages

45. Tax Planning Opportunities
Rent of related party owned buildings
Works best with C or S corporations
Paying kids through the business
Sole Proprietors not required to withhold or match Fica on their kids under 18
Kids have ‘0 tax bracket’ up to $6300 in income
Effect of proposed tax plan on business entities