What type of business entity is the company?
Choosing the right buy-sell strategy for your client
Sole proprietorship
Business controlled and owned by one individual.
Partnership
Business owned by two or more people who carry on the business as a partnership.
Limited liability company
A business entity that combines the limited liability of a corporation with the flexible management options of a partnership. LLCs can choose how they want to be taxed — as a sole prop, as a partnership, S corp or C corp.
S corporation
A separate legal entity that is comprised of three groups of people: shareholders, directors and officers. Shareholders elect a board of directors that manage and control the corporation. As a separate legal entity, the corporation is also a separate taxable entity. S Corporation is taxed in the similar manner as a Partnership. Income and expenses of the S Corporation flow through to the shareholders in proportion to their shareholdings and profits are taxed to the shareholders at their individual income tax rate.
C corporation
A separate legal entity that is comprised of three groups of people: shareholders, directors and officers. Shareholders elect a board of directors that manage and control the corporation. As a separate legal entity, the corporation is also a separate taxable entity. C Corporation reports its income and expenses on a Corporation Income Tax Return and is taxed on its profits at corporate income tax rates. Profits are taxed before dividends are paid. Dividends are taxed to shareholders, who report them as income, resulting in “double taxation” of profits, which are paid as dividends. Unlike sole proprietorships and partnerships, C corporation losses are deducted only at the entity level and are not passed through the entity to shareholders, while S Corporation shareholders can only take losses to the extent of their basis in the corporation.
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What type of business entity is the company?
This table outlines the attributes, advantages and disadvantages of different types of businesses. It can help you help your clients determine the appropriate buy-sell strategies for their business entity.
| Business entity | Advantages | Disadvantages | Appropriate arrangement |
|---|---|---|---|
| Sole proprietorship | Low organizational costs. Decisions made by owner. Fewer reporting requirements. Profits are taxed as income at personal tax rate. Corporate “double tax” is avoided. | Some IRS Code benefits not available to sole proprietorships Business terminates upon the death of the owner. Investment capital is limited to that of the owner. Owner’s assets subject to business liabilities | One-way buy-sell |
| Partnership | All partners share equally in the right and responsibility to manage the business Each partner is responsible for all debts and obligations of the business. Partnership agreement defines distribution of profits and losses, management responsibilities and other issues | Each partner is personally liable for all the obligations of the business. Each partner has the power to act on behalf of the business. All partners must pay tax on their share of partnership profits, although profits may be retained in the business. A general partnership has more opportunity than a sole proprietorship but less than a corporation, to take advantage of certain benefits afforded by the Internal Revenue Code. |
|
| Limited liability company | Members of the LLC maintain liability limited to the amount invested. Flexible management options. Business may choose its taxation entity. Can be perpetual. | Transfer of interest is limited. An investment is of limited liquidity since most if not all members must vote to transfer a member’s interest. | |
| S corporation & C corporation | No shareholder, officer or director may be held liable for debts of the corporation unless the corporate law was breached. The ready transferability of shares in the corporation facilitates estate planning. Corporations, to a much greater extent than sole proprietorships and partnerships, may take advantage of pension plans, medical payment plans, group life and accident plans and other benefits available under the Internal Revenue Code. The entity exists forever, so long as corporate regulations are met. There is no need to cease operations if an owner or manager dies. | Cost of organization, legal and filing fees can be expensive depending on the complexity and size of the business. Control is vested in a board of directors, elected by shareholders rather than control vested in the individual owners. Unlike sole proprietorships and partnerships, individual shareholders may not deduct cost basis in the entity unless the corporation has elected to be taxed as a S Corporation. Unlike sole proprietorships and partnerships, C corporation losses are deducted only at the entity level and are not passed through the entity to shareholders, while S Corporation shareholders can only take losses to the extent of their basis in the corporation. |
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DOFU 10-2022
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