Choice of entity type greatly impacts the legal and tax options available to a business. Depending upon the nature of the activity, certain business structures may be more advantageous than others. Business may be conducted as a Sole Proprietor, a “C" or “S” Corporation, a General or Limited Partnership, a Limited Liability Company, or as a Limited Liability Partnership.

SOLE PROPRIETOR: A sole proprietor is the most common business structure. A key drawback to this form is the owner’s unlimited liability in the event of a lawsuit. Take for example a Real Estate investor that owns an apartment building worth $500,000 and holds the property in their own name rather than form some type of holding company. During the time repairs are being made on the building, a tenant is injured. The owner initially is not concerned because they hold a $1,000,000 insurance policy on the property. Unfortunately, the tenant who was injured was a medical student finishing his residency in surgery. His attorney successfully argues that due to the severity of the injury, the doctor’s lifetime earning capacity has been drastically curtailed. Since the owner has unlimited legal liability, after the $1,000,000 of insurance proceeds has been paid, they lose the $500,000 building and likely most of their personal assets as well. This is a worse case scenario example that may be tailored to fit any business liability lawsuit. Sole Proprietorship’s can not only be a legal disaster but the tax planning options it affords are extremely limited. Net income reported on your personal tax return from an unincorporated entity is subject to approximately 15% Self Employment tax and income tax. If I net $30,000 from my own unincorporated business and report it on my individual tax return, my Self Employment tax would be about $4,200 and income tax at 25% would result in a federal tax liability of $7,500. This is a 39% effective tax rate. Doesn’t sound too good, does it?

CORPORATIONS: Operating as a “C” or “S” Corporation in most instances solves the problem of unlimited liability. In order for the Corporation to be viewed as a separate legal entity apart from its owner, the entity must be in “good standing”. This involves performing certain corporate formalities during the year as well as being current with all required Federal and State tax filings. When an entity is incorporated, it is initially a “C” Corporation. In most instances, the owners will benefit from an “S” Corporation election. An S Corporation is a hybrid of the Corporate and Partnership structure. As such, it provides tax planning strategies that are not available to “C” Corporations. The crux of these tax planning opportunities are in the areas of Officer Compensation, Pension Planning, and Corporate losses that are reflected on the Officer’s individual tax return.

PARTNERSHIPS: General Partnerships are utilized infrequently due to the issue of unlimited liability. In a General Partnership, all partners are General Partners and as such are subject to unlimited liability. In a Limited Partnership, at least one partner must be a General Partner. Limited Partnership’s may be structured with a Corporation serving as the General Partner. This accomplishes full limited liability for all shareholders, however now there are two entities that require corporate formalities, proper capitalization and tax returns. This proves cumbersome and may easily be remedied by initially forming a Limited Liability Partnership or Limited Liability Company.

LIMITED LIABILITY COMPANY / PARTNERSHIP: LLC’s or LLP’s provide the most “bulletproof” business structure available today in terms of legal liability. Many attorneys will not even pursue a lawsuit against a business when they discover it is an LLC. This is because even if the lawsuit is successful, no cash may be forced out of a properly structured LLC / LLP by the plaintiff. These entities also provide for some of the most flexible tax planning options contained within the IRS code. In certain situations, the tax reducing strategies that an LLC or LLP provides prove much greater than those available through other business structures.

Choice of or change in business entity can help reduce potential legal and tax liabilities. The firm of Robert M. Frumkin CPA, Inc. has provided this form of consultation for various enterprises and considers it one of the most crucial of all business decisions. The firm provides full incorporation services that includes annual guidance pertaining to the formal procedures needed to keep the corporation properly structured so that it provides the maximum degree of legal and IRS audit protection.

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