CHOOSING A BUSINESS ENTITY
by Jonathan Kramer, C.P.A.
The form in which you conduct your business
can have profound tax and legal liability implications. Summarized
below are four commonly used business entities listing their
primary advantages and disadvantages; Future articles will
discuss the other two commonly used business entities (C Corp
and S Corp) and other differences between all these forms
of doing business. You can also read more about business plans,
by clicking here.
Sole proprietorship - This
form is limited to single owners. It is the simplest form
of doing business, requires the least amount of paperwork
to establish, and is the most economical to maintain. No special
tax filings are required; however a detailed schedule of income
and expenses needs to be included annually with your individual
income tax return. This form of doing business provides no
liability protection, i.e. you can be sued for product liability,
personal injury or under any other legal basis for matters
related to your business.
General Partnership - This
form of business entity is similar to a sole proprietorship
but is used when there is more than one business owner. As
in a sole proprietorship, it does not afford its owners (partners)
any legal protection. Forming a general partnership is straightforward.
A partnership agreement should be executed defining the partners'
rights and responsibilities and setting forth the economic
relationship of the partners. A partnership return needs to
be filed annually listing the business' income and expenses;
each partner reports his share of the partnership net income
on his individual income tax return. One of the major advantages
of conducting business via a partnership is the flexibility
afforded partners to allocate the partnership net income amongst
them however they wish, provided that the allocation has "substantial
economic effect". This often creates tax planning opportunities.
Limited Partnership - This
form is identical to a general partnership except that there
is at least one general partner and at least one limited partner.
The limited partners are shielded from legal liability and
from any claim asserted against the partnership. The general
partner however is liable just as in a general partnership.
This form of entity is most commonly used when a business
venture requires investment capital. The investor receives
an equity participation in the venture for his capital contribution;
however his limited partner status guarantees him that he
will not be at risk other than for the amount of capital he
invested. Equally important, as in a general partnership the
partnership net income can be allocated amongst the general
and limited partners to maximize the tax advantages to the
limited partners who funded the venture. This form of doing
business requires significant paperwork and up-front costs
including legal fees and publication costs.
Limited Liability Company
- This newest form of doing business, adopted by most of the
States, is similar to a limited partnership with one major
exception. It does not require any of its owners (called members)
to have legal liability. In this regard it is similar to a
corporation which affords its owners (called shareholders)
legal protection. Most advisors believe that this form of
doing business is the "best of all worlds", providing
the legal liability protection of a corporation while allowing
the tax allocation flexibility of a partnership. This form
of doing business has been embraced by the real estate industry
as the entity of choice.
Editor's Note :
Jonathan Kramer, CPA, is a partner in the accounting
firm of Shanholt, Glassman, Klein, Kramer & Co.,
CPA's, with offices at 488 Madison Avenue, New
York, NY 10022.
Telephone (212) 644-9000; Facsimile (212) 752-4335
Mr. Kramer's firm has contributed this article in
the public interest. It is neither intended as legal
advice nor accounting advice. Nor is any professional
relationship intended or established with the reader
by virtue of browsing this article. Neither Mr. Kramer
nor Shanholt, Glassman, Klein, Kramer &
Co. CPA's, are affiliated with Hollander and Company
LLC. The information contained in the article is believed
to be accurate but should not be relied on without
independent advice of an appropriate professional.