39 Considerations When Choosing The Best Business Entity

Selecting the best business entity is critical to the long-term success of any company. There are many factors that make choosing one business entity more appropriate for your situation than others. Some basic considerations included:

• Are you starting a side hustle or a larger organization?
• Will you be bootstrapping the startup or will you need to raise outside money?
• Is your business at risk of being sued?
• Will you be the only owner and decision-maker or will you have partners and or shareholders?
• What is your personal tax situation?
• Do you have a lot of personal assets that you need to protect?

When creating a new business, you have five business entity types you can choose to use. Each business entity has its pros and cons, based upon a variety of factors. When choosing the business entity type that right for you, be sure to consider the future needs and situation of your business, not just its position in the present. The following series of tables is a definitive guide that looks at 39 considerations when choosing a business entity

Limited Liability for Owners

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Yes	Yes	No for General Partners Yes for limited partners.  Limited partners cannot be actively involved in the business without losing limited liability.  Limited liability partnerships (LLPs) may either 1, provide partners with protection from various liabilities, or 2, provide complete liability protection depending on the state’s LLP Act	Yes	No, liability is unlimited

Related Video: An LLC May Not Provide You Liability Protection

Flexible Ownership and Capital Structure

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Yes	No. Limited to 100 shareholders and one class of stock. Types of shareholders are limited to US Citizens and must be a person, not an entity	Yes. Need at least two partners	Yes. An LLC can have a single member or unlimited multiple members	No-one owner

Continuity of Life for Entity

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Yes	Yes, but stock ownership must be monitored	Generally, no. Terminates for Federal taxes if 50% or more of capital and profits interests are transferred during the 12 months.	If described in the operating agreement. Depends on state law provisions. For Federal, if 50% or more capital and profits interests are transferred during a 12 month	No

Related Video: Continuity of Life Explained

Centralized Management of the Entity

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Yes	Yes, but the number of shareholders is limited, so may not be practical	No for general partnerships, usually yes for limited partnerships. Limited partners cannot participate in management	Yes, when you elect manager-managed you centralized management. If you elect member-managed the LLC is no centralized management	No

Related Video: Centralized Management Explained

Free Transferability of Ownership Interests

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Yes, but may be contractually limited by the buy-sell agreement	Yes, but must observe limitations on who can own stock, May be contractually limited by a buy-sell agreement A buy-sell agreement	Generally, no. may be limited by buy/sell provisions in a partnership agreement or a separate agreement	Generally, no. may be limited by operating agreement provisions or in a separate agreement	No, but is a practical matter the entire business may be sold

Related Video: Transferability of Ownership Explained

Degree of Administrative Complexity

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
High	High	Moderate	Moderate	Low

Certainty of Legal and Tax Outcomes

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
High	High to Moderate	Moderate	Moderate	High

Double Taxation of Income

C-Corp	S-Corp	Partnership	Multi Member LLC	Sole Proprietorship
Yes, however, see Internal Revenue Code (IRC) section 1202 on qualified small business corps	No, unless former C-Corps and build-in gains tax applies	No	No	No

Ability to Retain Income at Low or Current Tax Costs

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Yes, however, distributions are taxed as qualified dividends that are subject to Capital Gains taxes	No	No	No	No

Tax Treatment on Fringe Benefits for Owners

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Good	Poor, if you own more than 2% of the stock	Poor	Poor	Poor

Flexibility to Select Tax Year

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Yes	Limited	Limited	Limited	Limited. [See Jerome H. Vance TC Memo 1989-95]

Passive Loss Rules

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
No unless Personal Service Corporation (PSC) or closely held Corp	Yes-at shareholder level	Yes-at partner level. Treatment of limited partners is unfavorable	Yes-at member level; unclear if members are treated as limited partners	Yes

Deductions of Corporate Dividends Received

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Yes	No	No	No	No

Owners Eligible for Loans Against Qualified Plan Accounts

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Yes	Yes	Yes	Yes	Yes

Forgettable Tax Rate on Long-Term Capital Gains

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
No, regular corporate rates apply	Yes	Yes	Yes	Yes

Double Taxation Upon Liquidations

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Yes	No, however, the sale may generate ordinary income from recapture that can be offset by the capital loss on the sale	No, however, the sale may generate ordinary income from recapture that can be offset by the capital loss on sale	No, however, the sale may generate ordinary income from recapture that can be offset by the capital loss on sale	No, however, the sale may generate ordinary income from recapture that can be offset by the capital loss on sale

Personal Holding Company Tax Applies

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Yes	No	No	No	No

Accumulated Earnings Tax Applies

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Yes	No	No	No	No

Unreasonable Owner Compensation Issue Applies

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Yes for unreasonably high compensation	Yes for unreasonably high compensation	No	No	No

Personal Service Corporation (PRC) Rules Apply

C-Corp	S-Corp	Partnership	Multi Member LLC	Sole Proprietorship
Yes, but to qualify employee-owners must perform at least 20% of the personal services themselves and must also own at least 10% of the outstanding stock.	No	No	No	No

Limitation on Use of Cash Method

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Yes but smaller corporations and PSCs can use cash method	No, unless the corporation maintains inventories or is a “tax shelter”. [1]	No, unless the partnership has a C-Corp partner, maintains inventories, or is a “tax shelter”. [1]	No, unless the LLC has a C-Corp member, maintains inventories, or is a “tax shelter”. [1]	No

[1] However, if a gross receipts test is met, a cash method may be used even if inventories are maintained

Limitation on Use of Net Operation Loss (NOL) and “Other Tax” Attributes After Ownership Change

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Yes	N/A Losses pass through to owners	N/A Losses pass through to owners	N/A Losses pass through to owners	No

Entry Level Alternative Minimum Tax (ATM)

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Yes but smaller corporations are excluded	No, but AMT information must be provided to shareholders	No, but AMT information must be provided to partners	No, but AMT information must be provided to members	No but AMT items can affects owner’s AMT calculation

Potential Ability to Reduce Payroll Taxes of Owner-Employees

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
No	Yes within limits of reasonableness	No, [2]	No, [2]	No, [2]

[2] May benefit from employing owners children under age 18

Potential Favorable Tax Treatment of Owner Level Interest Expense on Debt to Inject Capital Or Acquire Ownership Interest

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
No	Yes	Yes	Yes	Yes

Double Taxation at State Level

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Generally yes	Sometimes	Rarely	Rarely	No

Additional Owner Level Tax Bases for Entity Level to Debt or Loss Deduction Purposes

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
No	Yes but only for direct loans from shareholders	Yes	Yes but generally not for at-risk purposes	N/A But the owner gets basis for debt since no entity exists

Basis Adjustments Upon Purchase or Ownership Interest

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
No	No	Yes, mandatory basis adjustments may be required in certain transfers or distributions	Yes, mandatory basis adjustments may be required in certain transfers or distributions	No

High Flexibility to Make Tax-Free Contribution/Distributions

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
No	No	Yes	Yes	Yes

Ability to Make Special Tax Allocations Among Owners

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
No	No	Yes	Yes	No

Ability to Shift Entity Income Among Family Member/Owners

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
No	Yes to a degree by manipulating wages of employee-owners	Yes within the limits of family partnership rules	Yes within the limits of family partnership rules	Yes by employee family members

Possibility of Corporate Level Build-In Gains Tax, Excise Net Passive Income Tax, and Last-In First-Out (LIFO) Recapture Tax If Former C-Corp

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
No	Yes	No	No	No

Potential Loss of Favorable Pass-Through Tax Rules If Ownership and Capital Rules Violated

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
No	Yes	No	No	No

Treatment of Gain on Sale of Ownership Interest

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Capital Gains	Capital Gains	May be part of ordinary income under “hot assets‘ rules (See Internal Revenue Code section 751)	May be part of ordinary income under “hot assets’ rules (See IRC section 751)	May be part of ordinary due to recapture items

Treatment of Lost on Sale of Ownership Interest

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Capital gains unless stock is restricted stock under section 1244 stock	Capital gains unless stock is section 1244 stock	Capital gains. But ordinary income under “hot assets” rules may still be recognized	Capital gains. But ordinary income under “hot assets” rules may still be recognized	Generally, capital gains (depends on the nature of assets sold)

Section 465 At-Risk Rules (Tax Shelters) Apply

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
No, unless closely held	Yes at the shareholder level	Yes at the partner level	Yes at the member level	Yes

Section 179 Dollar Limitations Applied at Single Level

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Yes	No. The dollar limitation applies at the S-Corp level and again at the shareholder level	No. The dollar limitation applies at the partnership level and again at the partner level	No. The dollar limitation applies at the LLC level and again at the member level	Yes

Ownership Interest Available to Creditors

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Yes	Yes	Limited. The creditor can obtain charging order to receive distributions	Limited. The creditor can obtain charging order to receive distributions	Yes

Valuation Discounts Available for Real Estate Valuations

C-Corp	S-Corp	Partnership	Multi-Member LLC	Sole Proprietorship
Yes	Yes	Yes. The amount of discount depends on the terms of the partnership agreement	Yes. The amount of discount depends on the terms of the LLC operating agreement	Yes

What business entity is right for your new company?