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Pros and Cons of Differenty Business Types

An S corporation
is a special structure of business ownership by which the business is able to avoid double taxation because it is not required to pay corporate income tax on the profits of the company. All profits/losses are passed on directly to the shareholders of the company. The shareholders file individual tax returns and pay income tax on whatever share of profits they receive from the business. If the business has more than one shareholder the business must file an informational tax return to provide details of the corporate income of each shareholder.
Advantages of an S Corporation:

  • No Corporate Tax
  • Reduce Taxable Gains
  • Write off Start-up Losses
  • Liability Protection

Disadvantages of an S Corporation:

  • Limited to 35 shareholders
  • Can only use domestic capitalization
  • Shareholders pay taxes on all profits in the year earned, whether or not they are distributed.
  • Generally must operate on a calendar year

Corporations are remarkably different from other forms of businesses in the sense that it is an independent legal entity
that is separate from the people who own, control and manage it. Due to this recognition as an individual entity, it is viewed as a legal "person" in the view of tax laws, and can thus be engaged in business and contracts, can initiate lawsuits and itself be sued. It also must pay taxes.

A C corporation is a business term that is used to distinguish this type of entity from others, as its profits are taxed separately from its owners under subchapter C of the Internal Revenue Code. In an S corporation, the profits are passed on to the shareholders, and are taxed based on personal returns. This is done under subchapter S of the Internal Revenue Code.

A C corporation is owned by shareholders, who must elect a board of directors that make business decisions and oversee policies. In most cases, a C corporation is required to report its financial operations to the state attorney general. Because a corporation is treated as an independent entity, a C corporation does not cease to exist when its owners or shareholders change or die.

Another major advantage of a C corporation is that its owners have limited liability. Thus, they do not stand personally liable for debts incurred by the corporation. They cannot be sued individually for corporate wrongdoings.

Major Benefits of a C Corporation

  • As opposed to a sole proprietor or an LLC, corporations are usually at a lower risk of being audited by the government.
  • The owners and the shareholders of a C corporation have a limited liability towards business debts.
  • A C corporation can deduct the cost of benefit as a business expense. For example, they can write off the entire costs of health plans established for employees as business expenses. These benefits are tax-free even for those receiving them.
  • A C corporation can be used to split the corporate profit amongst the owners and the corporation. This can result in overall tax savings. The tax rate for a corporation is usually less than that for an individual, especially for the first $50,000 of taxable income.
  • In a C corporation, there can be an unlimited number of stockholders. This allows the corporation to sell shares to a large amount of investors, which allows for more funds to be raised for projects.
  • Additional funds can be raised by a C corporation by the way of sale of stocks if the company stands in need of finances for expansion
  • Foreign nationals have a right to own or invest in a C corporation. There is no binding on the type of investors as in the case of an S corporation. This lets a greater number of diverse investors participate in the business and also allows foreign money to flow in for investment.
  • The owner (majority shareholder) of a C corporation has the option of issuing different "classes" of stocks to different shareholders. This helps attract different groups of investors as common stocks and preferred stocks both have their own distinct advantages that may appeal to one but not to another.

There are various routine formalities that a C corporation needs to follow. These routines are an integral part of the working of a C corporation, and failure to follow these formalities can lead to serious consequences, including denial to recognize the company as a corporation. The formalities that need to be followed in a C corporation are:

  • Adequate investment of money (capitalization) in the corporation.
  • Formal issue of stocks to the initial shareholders.
  • Regular meetings of directors, and the shareholders.
  • Upkeep and update of business records and transactions of a corporation separate from those of its owners.

While a C corporation is an attractive way of forming a business due to its provision of limited liability to its owners, there are certain circumstances wherein the limited liability will not be able to protect the owner’s personal assets. An owner will be held personally liable if:

  • He or she directly injures someone personally.
  • He or she has personally guaranteed a loan or a business debt for the corporation, which the corporation fails to repay.
  • The person fails to deposit taxes that have been deducted from the employee wages by the corporation.
  • Such a person is part of intentional fraud or other illegal action that results in loss to the corporation, or someone else.
  • Such a person treats the corporation as an extension of his/her personal property, rather than a separate entity.
  • The courts rule that a corporation ceases to exist, as the corporate formalities have not been adhered to.

A Limited Liability Company, also known as an LLC, is a type of business structure that combines traits of both a sole-proprietorship and a corporation. An LLC is eligible for the pass-through taxation feature of a partnership or sole proprietorship, while
at the same time limiting the liability of the owners, similar to a corporation. As the LLC is not considered a separate entity, the company does not pay taxes or take on losses. Instead, this is done by the owners as they have to report the business profits, or losses, on their personal income tax returns. However, just like corporations, members of an LLC are protected from personal liabilities, thus the name Limited Liability.

Limited Liability Companies are recognized in all 50 states and the District of Columbia. In most states any type of business can form an LLC, though some state laws may require at least two members in order to form one.

Advantages of an LLC

  • The members of an LLC have protection against liability. They cannot be held liable for company losses, or debts and business credit, and their personal assets (such as a house or car) cannot be recovered by the debtors.
  • LLCs have the freedom of selecting any form of profit distribution, which does not have to be in the ratio of the ownership between different members.
  • LLCs do not have a legal requirement to conduct formal meetings, maintain minutes of the meeting, or record resolutions.
  • Benefits similar to a corporation are available without going through any incorporation formalities.
  • Pass-through taxation principles apply and the company itself is not taxed unless it opts for being treated as a regular corporation. All business profits, losses, and expenses are accounted for by its individual members. Members have to show the earnings in their individual tax returns and accordingly pay taxes. This allows the avoidance of double taxation by way of corporate tax payment along with the individual income tax.

While the advantages largely benefit most small businesses, certain aspects of an LLC can prove to be disadvantageous. This is especially true for larger organizations. Some of the disadvantages of an LLC are:

  • LLCs have a limited life and are usually dissolved when a member dies, or if the company faces bankruptcy.
  • LLCs cannot go public, as there are no shares or shareholdings. For the same reason, issuing shares to employees through stock options is not possible.
  • Even though the paperwork and the complexities associated with LLCs are significantly less than those required for forming a corporation, its formation is still substantially more complex than a partnership or sole-proprietorship.

In most states, an LLC can be created simply by filing the "articles of organization" and paying the required filing fee. This document is also known as a "certificate of organization" or a "certificate of formation”. Some states have an additional requirement of publishing an intention to create an LLC in a local newspaper. Another part of forming an LLC is the operating agreement, which is not compulsory in most states, but is highly recommended. This document explicitly states the rights and responsibilities of the LLC owners.

Business partnerships can be either general or limited, and as far as tax codes are concerned, exist as long as profits, losses and costs of a business are shared. While general partnerships are more common, limited partnerships are a popular method of
raising capital from passive investors who prefer to not be involved in day-to-day business operations. Limited partnerships (LPs) have two sets of partners, namely one or more general partners who have personal liability and one or more limited partners who are not liable for debts. Business owners who do not want the liability for the debts incurred by the corporation prefer this option. Limited partners usually do not play any role in the day-to-day management of the company.

Pros of Limited Partnerships:

  • Generally, pass-through taxation is applicable to limited partnerships, meaning that the tax burden is passed on to the partners instead of the partnership itself. Thus, profit earnings are passed on to the partners in the form of wages, income, and profit payments and each partner pays tax that is proportionate to his individual share of profits.
  • A business can obtain much-needed investment capital by giving more passive investors the option of reducing their risks by becoming limited partners
  • Since there is no direct involvement of limited partners in the management of the business, general partners enjoy full autonomy and have the right to make important business decisions.
  • In the case of a general partnership, all partners are responsible for the debts and other liabilities. The liability of a limited partner does not exceed his capital investment in the company.

In the event of a lawsuit the names of the limited partners cannot be included in the list of defendants. Limited partnerships are quite common in businesses such as restaurants and other business ventures where there is high financial risk. The limited partners will only provide the necessary funds, and stay aloof from the business operations and management. Due to this lack of involvement in management of business, LPs are also called “passive investors”. In order to enter limited partnership, partners need to file the necessary formation documents with the concerned state agency along with the state filing fees applicable.

Cons of Limited Partnerships:Limited partnerships do have downsides:

  • Certain tax rules restrict LPs from claiming partnership losses beyond $25,000 per year. If losses exceed this amount the partners can carry forward the amount of passive investment losses to be claimed in the tax returns for the following year. This limit is exercised each tax year and is applicable to all those who are only concerned with the capital aspect of business ventures and in no way interfere in the business affairs.
  • It is fairly easy to compute tax if partners have invested only cash. However, if non-cash financing options, such as vehicles or real estate, are involved more complicated tax rules are applicable.
  • Sometimes limited partners may be tempted to participate in the management of the business and may therefore want to step out of the passive investor role. This kind of involvement may make them general partners and forbid them from exercising their limited liability privilege.