Choosing the Proper Entity

 

Choosing the proper type of entity in business is like choosing the proper spouse in personal life. We need to ask many questions, summarize the facts, realize that we don’t know what the future holds, then make a decision on the facts while listening to our gut (professional judgment).  It is also critical for businesses that are newly created or in a state of transition that the business owners evaluate a set of confusing federal and state tax and legal issues and consider personal issues when deciding what type of entity their business should be.  This section is designed to give the tax practitioner the tools he or she needs to steer our clients through the issues.

 

Failure by the practitioner to fully understand the attributes of each business form can result in a recommendation which can cost the client additional tax dollars, reduce or limit employee benefits and increase malpractice potential in the case of business failure.

 

The following information is a two page Comparison of Entities Checklist that you can use to compare the difference between the six major choices in entity selection.

 

Item

Characteristic

Sole Proprietor

Single Member LLC

“C” Corp.

“S” Corp

Partnership

Multi-Member LLC

 

Title

Owner

Member

Shareholder

Shareholder

Partner

Member

1

Limited Liability

No

Yes

Yes

Yes

No (a)

Yes

2

Lower Audit Profile

No

No

No

No

Yes

Yes

3

Continuity of Life ( c )

No

No

Yes

Yes

No  

Maybe

4

Centralized Management ( c )

Yes

Yes

Yes

Yes

Maybe

Maybe

5

Free Transferability of Interests ( c )

No

No

Yes

Yes

No

Maybe

6

Number of Owners

1

1

1 or more

1 to 75

2 or more

2 or more

7

No Restrictions on Ownership

Yes

Yes

Yes

No

Yes

Yes

8

Can Easily Select a Fiscal Year End

No

No

Yes

No

No

No

9

Can Deduct 100% of Owner’s Health Ins.

Yes

Yes

Yes

Yes

Yes

Yes

10

Can Deduct Owner’s Portion of Group Term Life up to $50000

No

No

Yes

No

No

No

11

Able to Use Lower Corp. Tax Rate

No

No

Yes

No

No

No

12

Able to Compensate an Employee With Equity

No

No

Yes

Yes

Yes

Yes

13

Can Split Income With Family Members

No

No

Yes

Yes

Yes

Yes

14

Double Tax-earnings, Liquidation & IRS Audit Adjustments

No

No

Yes

No

No

No

15

Can Avoid FICA Taxes by (A) Distributions or (B) Paying Children Under 18

(A) No (B) Yes

(A) No (B) Yes

(A) No (B) No

(A) Yes (B) No

(A) No (a)  (B) Maybe

(A) Maybe (B) Maybe

16

Subject to: (A) Distributions (B) PHC & AE Tax

(A) Yes (B) No

(A) Yes (B) No

(A) Yes     (B) Yes

(A) No (B) No

(A) No (B) No

(A) No (B) No

17

Able to Deduct Business Loss on Individual Return

Yes

Yes

No

Yes

Yes

Yes

18

Can Transfer Assets ‘Tax Free’ Where 80% Control Test is Not Satisfied

N/A

N/A

No

No

Yes

Yes

19

Can Increase Basis by ‘Set-up’ Election

N/A

N/A

N/A

No

Yes

Yes

20

Can Specially Allocate Items of Income & Expense

N/A

N/A

N/A

No

Yes

Yes

21

Can Deduct Interest on Money Borrowed to Invest as Business Interest

Yes

Yes

No

Yes

Yes

Yes

        

25

Can Transfer Assets ‘Tax Free’ where debt > basis

N/A

N/A

No

No

Yes (d) 

Yes (d)

26

Basis for Loss Includes Owner’s Share of company Debt

N/A

N/A

N/A

No

Yes

Yes

28

Qualities for Ordinary Loss Under Section 1244

No

No

Yes

Yes

No

No

29

May Offset Active Income With Passive Losses

No

No

Yes

No

No

No

22

Can Use Cash Basis Even if Sales > $5,000

Yes

Yes

No (b)

Yes

Yes

Yes

23

Inexpensive to Form & Maintain

Yes

Yes

No  

No

No

No

24

Able to Deduct Expenses Paid Personally in computing AGI

Yes

Yes

No

No

Yes

Yes

27

Existence of Reliable Case Law

Yes

No

Yes

Yes

Yes

No

30

Can Easily Distribute Back the Owners Investment

Yes

Yes

No

Yes

Yes

Yes

31

Home Office Deduction

Yes

Yes

No

No

Yes

Yes

32

Avoid Payroll Taxes & Administration (if no employees except owner)

Yes

Yes

No

No

Yes

Yes

33

Can Deduct Medical Costs

Yes (e)

Yes (e)

Yes

No

Yes (e)

Yes (e)

 

Note: A “Yes” answer suggests a favorable response.  A “No” answer suggests an unfavorable response.

(a) Yes if a limited partner

(b) Except certain farms & PSC’s

( c ) Unimportant with check the box Regs.

(d) Yes unless partner basis is zero

(e) Sec. 105/106 health insurance plan

Other considerations: State Tax Issues.  Entities Permitted.  Multi-state Capabilities.  Estate Issues.  Retirement Issues.

Bitnami