There are times when a new client will come to our firm, and they are
trying to decide what type of entity to choose for their new business
venture. To figure out what type of entity we need to figure out what
exactly the business is and typically what type of liability the owners
will have or need to have protected.
A sole proprietorship is a business that an individual reports typically
on a schedule C or F on their individual tax return. On advantage is
there is no other federal tax return requirement since the information
is reported in the individuals return. Some disadvantages are that
there can only be one owner and there is no liability protection for
that person. A sole proprietor can take money out of the business at
any time since only the income and expenses are reported on their
individual tax returns.
A partnership can be defined as a general partnership, limited
partnership, or a limited liability company. An advantage to forming a
general partnership is that entity can have two or more members.
[Another advantage is] a partnership is a tax reporting, but not
taxpaying, entity (Anderson, Hulse & Rupert 2023). Each partner gets
a K-1 and the income is reported on their tax returns. The positive
side to getting a K-1 and reporting the income is that these members
can take money out of the partnership by taking tax free
distributions. A disadvantage is that there is no liability protection.
The partners are all liable for any debts that the partnership cannot
pay.
A C corporation has the best advantage as the shareholders do not
have any liability to the company personally. A C Corporation also
have the biggest disadvantage which is the shareholders cannot take
distributions without getting double taxation. The only way a
shareholder can take money out of a C corporation is to take wages
or to take taxable dividends.
The taxable entity I chose for the new business owner is a
partnership. The business is investing in large real estate transactions
to be converted as rentals (for example, large apartment complexes).
This is the safest choice for a few reasons. They can choose a
partnership to have the partners liability be limited, which is
beneficial if they start purchasing multiple large pieces of real estate
and have a sum of mortgage loans over $10,000,000. Another reason
they should choose a partnership is that they can take large
distributions in income producing years that are not included in
income. The last benefit is that when the partnership is starting up
the partners can deduct the partnership loss on the k-1 to the extent
of the partners basis in the total debt on the balance sheet. For
example, if there is a $10,000,000 debt on the balance sheet on the
liabilities section the partners can deduct a loss up to $10,000,000. If
that loss is not met on the first year, they can keep having a loss until
the total debt is used (which hopefully doesn’t happen, or they will
not have a profitable partnership).
References:
Anderson, Kenneth E., Hulse, David S., Rupert, Timothy J. (2023).
Pearson’s Federal Taxation 2023 Corporations, Partnerships, Estates
and Trusts. Pearson Education Inc. Hoboken, NJ.
