VII. Sole Proprietorship, Partnerships, LLCs, and Other Entities

Sole Proprietorship

Advantages of a Sole Proprietorship

  • All income and losses are reported by the owner
  • No accumulation earnings tax or reasonable compensation limit

Disadvantages of a Sole Proprietorship

  • No income-splitting
  • Benefits are taxable to the owner, except health insurance

Other Considerations for Sole Proprietorships

  • Net operating losses can be carried back 2 years and forward 20

Partnership

Advantages of a Partnership

  • Income-splitting among owners
  • Pass-through of income and of losses, up to basis
  • Basis is increased for partnership liabilities and non-recourse debt
  • No income from the distributions of property or in a liquidation
  • No accumulation earnings tax or reasonable compensation limit

Disadvantages of a Partnership

  • Income is self-employment income
  • Benefits for partners are taxable, except health insurance

Other Considerations for Partnerships

  • IRS recognizes family members as partners only if capital is a material income-producing factor or substantial services are performed
  • IRS may reallocate distributive shares if disproportionate to capital contribution or services

Limited Partnership

Advantages of a Limited Partnership

  • Income-splitting among owners
  • Pass-through of income and losses, up to basis
  • Basis is increased for partnership liabilities and non-recourse debt
  • No self-employment income is received
  • No accumulation earnings tax or reasonable compensation limit

Disadvantages of a Limited Partnership

  • Losses are passive, not deductible against active income

Other Considerations for Limited Partnerships

  • Limited partners cannot be involved in management

Limited Liability Company (LLC)

Advantages of a LLC

  • Income-splitting among unlimited investors
  • Pass-through of income and losses, up to basis
  • Basis is increased for company liabilities
  • No accumulation earnings tax or reasonable compensation limit

Disadvantages of a LLC

  • Capital gains may result from converting a corporation to an LLC
  • Income is self-employment income
  • Benefits for members are taxable like benefits for partners, except health insurance

Other Considerations of a LLC

  • A family LLC can be used for estate tax advantages
  • Different ownership classes and allocations can be created
  • Transfer of interests is restricted
  • Departing members must be bought out, often on short notice
  • An LLC is not appropriate if a public offering is planned

Personal-Service Corporation (PSC)

Advantages of a PSC

  • Corporate tax breaks such as fringe benefits

Disadvantages of a PSC

  • Flat 35% income tax
  • Passive loss limits apply

Other Considerations of a PSC

  • Corporation features, such as limited liability

Personal Holding Company (PHC)

Advantages of a PHC

  • No income tax advantages over the C corporation

Disadvantages of a PHC

  • 20% penalty tax on undistributed income

Other Considerations of a PHC

  • Ownership and income tests apply
  • An S corporation cannot be a PHC
  • Estate tax advantages may apply

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