Advising Clients on Type of Entity

Tax Law and News tax professional with clients

One of the common questions a client may ask you is whether the should incorporate their business. Or perhaps, your client saw an article online about the advantages of LLCs, and now seeks your guidance on if they should create one for their business.

Let’s explore, at a basic level, some of the advantages and disadvantages of some of the more common business entity types.

Sole Proprietorships

A sole proprietorship is the simplest and most common business structure. This is an unincorporated business with one owner. There is no legal distinction between the business and the owner. Here are some advantages and disadvantages of sole proprietorships:

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Partnership

At a fundamental level, a partnership is the agreement of two or more people to go into business together. At the federal level, a partnership is not taxed, but instead serves as a conduit to distribute all of the income and expenses to the partners.

When advising your clients on establishing a partnership, consider the various types, including the following:

  • General Partnerships
  • Limited Partnerships
  • Limited Liability Partnerships
  • Limited Liability Limited Partnerships (not recognized in all states)
  • Joint Ventures

Each of these types of partnerships has its own advantages and disadvantages, and many of those factors will depend on the nature of the particular business. This article presents advantages and disadvantages of partnerships at a general level:

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S Corporation

An S corporation is a legal entity separate from its owner or owners. While it has similar requirements to a C corporation, it also has a pass-through feature like a partnership. Of course, there are specific requirements for making the S election, so become familiar with those before advising your client of this option. Here are some advantages and disadvantages of an S corporation:

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C Corporation

A C corporation is also an incorporated entity that is separate from its owners. Most larger corporations, including publicly traded companies, are C corporations. Here are some advantages and disadvantages of C corporations:

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Resources

  • IRS Publication 542 Corporations
  • IRS Form 1120 U.S. Corporation Income Tax Return (Instructions)

Limited Liability Company

A limited liability company has a hybrid legal structure. For federal tax purposes, an LLC is not a separate entity, but for some states it is. When your client chooses to form an LLC, you should also discuss what type of tax entity the business will have for federal filing purposes. An LLC can be a sole proprietorship (Single-Member LLC or SMLLC), a partnership or a corporation.

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