In: Accounting
Why might an individual choose to form a proprietorship over a partnership or vice versa. An LLC over a C-Corporation or vice versa.
Before setting up a business, one should decide which form it should take i.e.. a sole proprietorship, partnership, Limited liability partnership (LLC), or a Joint Stock Company. The decision about its structure depends on one’s risk-taking capacity, availability of finance, willingness to share profits, etc.
An Individual might choose to form a sole proprietorship over a Partnership or Vice versa because of the following reasons:
Sole Proprietorship: It is a business owned by one person and is the easiest to form with few government regulations. The owner has all the control over business activities. He assumes the responsibility for decision making. For assuming the responsibility, the owner enjoys all the profits. The flip side is the business dissolves when the owner dies. In case of losses, the owner has to bear it all. Most importantly, the proprietor has to depend on personal sources for financing the business. He has unlimited liability in case of losses meaning his personal property is liable.
Partnership form of Business: It is jointly owned by two or more people. It is complex but relatively easier to form. A group of individuals shares the responsibility to run the business. Financing becomes easier as the partners bring in capital. The problem of discontinuity doesn’t arise. But partners have unlimited liability. Since decisions are jointly taken, conflicts might arise. Apart from sharing the responsibility of running a business, partners also share profits which are often viewed as a negative point.
LLC(Limited Liability Company) vs C corporation or vice versa:
The choice depends on how one wants to raise capital, will he want the business to operate to share profits, what is the best way to exit, etc.
If an individual wants to go for a traditional way of raising capital, wants the business to grow as fast as possible to reach an exit, C-corporation is the better option.
However, if an individual doesn’t want to get pressured by the lenders, or doesn’t want to grow the business for selling, LLC offers a great option. Below are few advantages and disadvantages of LLC and C Corporation.
Advantages of LLC, Disadvantages of a C corporation
1. Only one layer of tax: LLC is subjected to a single tax layer i.e. member level. C Corporation is subjected to taxes at the corporation level and also member level.
2. Sale of assets: Purchasers of businesses choose to get a basis step-up in the assets of the business. This is possible in the case of an LLC and not with a C corporation.
3. Tax-Free Distributions of Appreciated Property: An LLC can distribute appreciated property among its members. The distribution of appreciated property to its shareholders in C corporation is subject to tax.
Advantages of C Corporation, disadvantages of LLC:
1. Benefits of Qualified Small Business Stock: It is possible to issue “qualified small business stock” by the C corporation whereas, LLCs cannot issue qualified small business stock.
2. Self-Employment Taxes: Shareholders of C corporation are not subject to self-employment taxes but members of LLC are subject to such taxes.
3. Tax Rates: C corporation tax rates (highest tax rate is 21%) are lower as compared to individual tax rates (the highest federal individual income tax rate is 37%).