Tax planning is something that should be considered
in every aspect of the way you do business. The basic
structure of a business should especially be considered
from a tax perspective. The table below compares six
types of entities or forms of doing business. Each has
advantages and disadvantages from a variety of perspectives
including the tax perspective. The type of entity selected
for a business should be looked at with great care.
Recent studies suggest all of the entities shown are
viable and under the right circumstances can result in
the lowest possible tax. Notwith-standing conventional
wisdom, which by the way does change from year-to-year,
all of these types of entities have their place in a
viable tax structure for a given individual, but which
of these entities is best selected is dependent on a
number of factors.
One clear trend is demonstrated
by the movement away from sole proprietorships that
do not afford any protection from liability with respect
to the business. However, a one-member limited liability
company (“LLC”)
will give you proprietorship tax treatment while preserving
limited liability. Limitation of liability and using
limited liability entities to protect assets is becoming
the number one way to safeguard property in a more and
more litigious society.
A detailed analysis of the most
recent tax data indicates that, in fact, “C” corporations,
where the circumstances are correct, are the right
choice of entity with respect to the form of organization
for a business. It is important to thoroughly examine
all the facts and circumstances and tailor entity selection
carefully according to the needs of the business and
the goals and objectives of its owners.
| |
Income
taxation |
Liability |
Self - employment tax |
Deductibility
of losses |
Special
considerations |
| Sole proprietorships and one- member
LLCs |
Income is included on the owner’s
individual tax return. |
The owner generally is not protected
from liability. For LLCs see below. |
The owner’s net income is fully
subject to self-employment tax. |
If the owner actively participates,
losses are fully deductible against other income.
The owner may carry back or forward net operating
losses. |
Because business income or loss flow
through to the owner’s personal tax return,
other items (such as deduction limitations) can be
affected. |
| Partnerships |
Income flows through to each partner’s
individual tax return. |
General partners are subject to unlimited
liability. Limited partners have liability to the
extent of their investment. |
General partners are subject to the
tax on partnership income, but limited partners usually
are not subject. |
Generally, partners can deduct active
partnership losses against other income, up to their
basis and passive losses only against passive income. |
Income from a partnership is taxable
regardless of whether partners receive an equivalent
amount of cash as a distribution. |
| Limited liability companies (LLCs) |
Recent check-the-box regulations have
made qualifying an LLC for partnership taxation much
simpler. |
Members’ liability is limited — similar
to that of corporate shareholders. |
Members are generally subject to the
tax except those qualifying as limited partners had
the entity been a limited partnership |
If an LLC is taxed as a partnership,
the loss rules follow partnership rules. |
Generally, LLCs have the flexibility
of partnerships with the limited liability of corporations. |
| S corporations |
Income flows through to each shareholder’s
individual tax return. In some instances, taxation
can occur at the entity level. |
Shareholders’ personal liability
is limited. |
Shareholders with income from their
proportionate shares of company earnings are not
subject to the tax. |
Shareholders can deduct losses to
the extent of their basis, but — unlike partnerships — shareholders’ proportionate
debt share does not increase their basis. |
The maximum income tax rate (39.6%)
is higher than for C corporations (35% once the lower
graduated brackets are phased out). |
| C corporations |
C corporations are taxed on their
earnings and shareholders are taxed on any dividends
they receive. |
Shareholders’ personal liability
is limited. |
Does not apply. |
As a separate taxpayer, corporations
can deduct losses or carry them back or forward to
offset income in profitable years. |
Income can be subject to an alternative
minimum tax of 20%. |
| Virginia small business trusts |
Partnership taxation or trust taxation |
Beneficial owners liability is limited |
Similar to partnership if beneficial
owner has no voice in management. No SE tax. |
Treated like LLCs |
Trustee controls entity beneficiary
the analog of limited partners but with different
and generally far lesser rights |
