Pros & cons of various business structures

Below is a review of the basic characteristics of various legal forms of business enterprise. 

 

Sole Proprietorship

 

In a sole proprietorship, business activities are not separate from other activities of the entrepreneur. This form is best suited for single-owner business that does not have tax concerns and for which potential product and/or service liabilities are minimal.

 

Pros:

·                    The owner (proprietor) has sole control over the business.

·                    It is simple and inexpensive to create and operate.

·                    Income, deductions, and expenses are paid by the owner, who reports it on his or her personal income tax return. The company is disregarded as an entity for taxation purposes. Though in New York City and some other municipalities, an unincorporated business tax is imposed.

 

Cons:

·                    There is no limit on personal liability for business activities. The creditors can go after the owner’s personal assets in order to satisfy debt.

·                    Access to capital and other business resources is limited by owner’s assets or personal ability to get loans.

·                    Business operations are wholly dependent upon the owner’s performance; this is risky, in that illness or other factors may impede the owner from working.

 

General Partnership

 

A general partnership is not separate from its owners, and the partners are personally liable for the debts of the business. It is best suited for multiple owners, all of whom will manage the company, and potential product and/or service liabilities are minimal for their type of business.

 

Pros

·                    It is simple and inexpensive to create and operate.

·                    The company does not pay taxes. Income, deductions, and credits pass through to the partners in the portions set forth in a Partnership Agreement, and they pay applicable taxes. Bear in mind that New York City and some other municipalities impose an unincorporated business tax on partnerships that operate within their borders.

 

Cons 

·                    Partners are personally liable for business debts and lawsuits. Most importantly, each partner is also personally liable for the actions of other partners. In other words, if the liable partner does not have enough assets to cover damages, creditors can go after the personal assets of other partners in order to satisfy debt that is incurred during the business activities of their partnership.

·                    It is difficult to remove and/or change partners without dissolving the partnership unless otherwise specified in a formal agreement. The entire business venture dissolves upon separation of a single partner, unless otherwise initially agreed upon. Therefore, it may be difficult to deal with an uncooperative partner; he or she will have much leverage, knowing that business continuity depends on his or her participation 

 

Limited Partnership

 

A limited partnership has two or more owners; at least one is a general partner and another is a limited partner. The company exists as a separate legal entity from its owners. It is best suited for two or more owners, when one seeks a passive investment with no interest in day-to-day management of the company.

 

Pros

·                    Partners can claim losses and business expenses as personal tax deductions. The taxes are reported and paid by each partner separately. In New York City and some other municipalities, partnerships are subject to an unincorporated business tax.

·                    Liability of a limited partner can be limited to the extent of his investment. He or she only stands to lose the amount invested in the company, and personal assets are not vulnerable. 

·                    Limited partners do not participate in company management.

 

Cons

·                    General partners are personally liable for business debts and lawsuits, and this includes the actions of other partners. Creditors can go after personal assets of each general partner.

·                    It is difficult to remove general partners without dissolving the partnership unless otherwise initially agreed upon and formally documented. Accordingly, partners depend on each other’s cooperation.

 

Limited Liability Company

 

A limited liability company is a separate legal entity from its owners. It is best suited for single or multiple owners who seek protection from unlimited liability and single-level taxation.

 

Pros

·                    Liability is limited to the extent of owner’s investment; personal assets are protected.

·                    Profits and losses may be allocated differently than owners’ contributions, upon agreement between them.

·                    Capital can be raised through the sale of company interest.

·                    The entity does not pay taxes separately from its members. The income, deductions, and credits are applied to the members in portions set forth in an LLC Agreement, and they report it on their personal income tax returns; however, members are taxed on allocations, not distributions of the profits, so they will owe taxes even if they decide to reinvest the profits rather than take it for themselves. One exception is the unincorporated business tax imposed by some municipalities (such as New York City) when an LLC has more than one owner.

·                    LLC owners have a choice regarding taxation; they can choose to be taxed as a corporation if it is more beneficial in their particular situations.

 

Cons

·                    It can be difficult to raise capital. The sale of membership interests in an LLC can create concerns or challenges for investors, as not everyone is interested in becoming an official LLC member.

 

Corporation

 

Corporation owners are referred to as shareholders. The corporate entity can have an unlimited number of shareholders; thus, this form is best suited for multiple-owner business seeking both limited liability and established procedures for management and funding.

 

Pros:

·                    There is limited owner liability for business debts and lawsuits. Owners may only be personally liable in certain situations when their activities can be proven to be egregious.

·                    Capital can be raised through the sale of stock rather than through bank assistance or personal loans.

·                    Lawsuits are brought against the corporation rather than against the owners or managers of the company. The payment for liabilities is limited by the company assets.

·                    There are tax-deductible fringe benefits, including health insurance and retirement plans.

 

Cons:

·                    There are many administrative formalities in managing the company (mandatory regular shareholders and directors meetings, documentation of every major decision and maintenance of records, etc.).

·                    Shareholders are exposed to double-taxation. When a corporation earns income, it pays taxes on the earnings as an entity. After that, if a corporation distributes dividends to its shareholders, the shareholders are taxed again on that dividend income. Shareholders first pay taxes on the overall profit as a company, then secondarily pay taxes on individual share of profit. Double-taxation may be mitigated by expenses and losses. Also, corporate income may be distributed in form of compensation rather than dividends, but this may be done only to the shareholders, who are simultaneously employees of the company. 

 

S Corporation

 

Generally, an S corporation is a closely-held company, a good choice for small or family businesses that seek to avoid the double-taxation imposed on a corporate entity, while preserving limited liability and established procedures for business operations and funding.

 

Pros:

·                    The S corporation offers all advantages of a regular corporation.

·                    In addition, there is only one level of taxation. The company does not pay taxes on income, and only shareholders pay taxes. However, shareholders do owe taxes on business income even if the profits are not distributed (for example, reinvested in the business). This taxation form is similar to the taxation of LLC members, except that New York City does not recognize S corporation status for NYC tax purposes, so S corporations in NYC must pay entity-level city taxes if the business is located in New York City.

 

Cons:

·                    The company may not have more than 100 shareholders and cannot publicly trade its shares.

·                    Nonresident aliens (residents of other states) cannot be shareholders.

·                    Generally, another corporation, an LLC, or a partnership cannot be a shareholder; only individuals can buy shares. 

·                   Administrative duties can be complex for small business owners. They have to go through extensive procedures in order to set up, operate, and dismantle the company.

 

This overview of various types of legal business enterprise structures should give you an understanding of the pros and cons for each, enabling you to decide what will work best for you and your business practices. To make an optimal decision regarding the form as well as applicable taxation, you should individually consult with a business attorney and discuss all features pertaining to these structures in greater detail.

Leave a comment

Make sure you enter all the required information, indicated by an asterisk (*). HTML code is not allowed.