By Wilson Tat

Accounting C104
Organizations to Consider
C and S Corporations
Formed through Articles of Incorporation
Separate legal entity from owners
C and S Corporations differ in tax treatment
General and Limited Partnerships
Formed through partnership agreement
Limited partnerships also need certificate of limited partnership
Flow through entities (All assets and liabilities flow through to
owners)
Limited Liability Company
Formed through Articles of Organization
Separate entity similar to corporations but treated as
unincorporated

Pros of Corporations
Separate legal entity
Limits owners liabilities in company
Tax Deferred transfers of property (Section 351)
Able to defer gains and losses for more favorable tax
basis
Limited involvement from shareholders
Liquidating entity at a loss has double benefit
Benefit at corporate and shareholder level

Pros of Specific Corporations
C Corporaitons S Corporaitons
Easy to raise funds through
sale of stock (IPO)
No restriction number and
type of owners
Flexibility in choosing
accounting periods

Treated as flow through
entity
Only one level of tax
Can choose between cash or
accrual method of accounting
Employee-Shareholder of S
Corporations receive income
allocation of business income
that is not subject to FICA or
self employment tax

Cons of Corporations
Legal restrictions corporations
State corporation laws specify rights and responsibilities
of corporations and shareholders, leaving little room for
flexibility
Contributions to corporation are tax deferred only if
contributor has 80% control of corporation
Entity losses are not deductible in year incurred (but
can be carried forward)
Liquidating entity at a gain also double taxed
Costly to convert entity to flow through entity

Cons of Specific Corporations
C Corporations S Corporations
Double Taxation (Can be
mitigated)
Corporate earnings taxed at
corporate rate before after tax
earnings taxed at shareholder
level
Restricted to accrual method
of accounting
Employee-Shareholder
compensation subject to
FICA taxes

Most restrictive rules on number
ad types of owners
Max 100 unrelated
shareholders
Cannot have corporations,
nonresident aliens,
partnerships or certain types
of trusts as shareholders
Cannot raise funds through
IPOs
Cannot choose accounting
period
Flow through entities follow
owners accounting period
Pros of Partnerships
Flexibility in legal arrangement
More power to alter management practices and responsiblities to
suit owners needs and preferences
Flow through entity (one level of tax)
No restriction on number & type of owners (must have at least 2)
Can defer gains on contributions for profits interest
Taxed only on profit allocated to owner
Can choose with accounting method to use
Distributions treated as nontaxable return of capital; excess of
basis as capital gain to owners
Entity losses deductible on owners personal income
Easier and less costly to convert to other types of entities


Pros of Specific Partnerships
Limited Partnerships Limited Liability Company
Can form partnership with
General and limited partners
General partners are
responsible for liabilities of
company
Limited partners contribute
assets for interest in
company but have no
management power
Useful in limiting
management of company
Separate legal entity similar
to corporations
Owners protected from
liabilities of the company

Cons of Partnerships
Limited liability protection (Flow Through Entities)
Owners are generally responsible for all assets and
liabilities for company
Harder to raise funds from external sources
Limited to accounting period of owner
Selling of interest characterizes gain by ownership
interest in assets
Liquidating entity at loss is a deferred loss
Generally subject to all FICA and Self-Employment
Taxes
Recommendation: Forming a
Limited Liability Company
Since both plan to devote equal time and share profits,
Partnership is recommended
Liability protection
LLC is responsible for liabilities, limiting owner risk
More favorable tax treatment
Flow through entities provide one level of tax
Can elect to be taxed as partnership or S Corporation
More flexibility in organization structure
Cash based method of accounting desirable for retail business
Tax free options to convert to other entity types
More room for future growth
Could change to corporation in future to have option for IPO
Spilker, Brian, Ben Ayers, John Robinson, Ed Outslay, Ron
Worsham, John Barrick, and Connie Weaver. Taxation of
Individual and Business Entities. New York: McGraw-Hill, 2014.
Print.