SCORE Los Angeles Business Guidance Documents

Business Organization Types

There are five types of business organization

• SOLE PROPRIETORSHIP
• GENERAL PARTNERSHIP
• LIMITED PARTNERSHIP
• LIMITED LIABILITY COMPANY (tax pass through like an S-Corporation)
• CORPORATION (& S-CORPORATION)

In the first two types, each "owner" has unlimited personal liability for all debts and liabilities of
the business.

At least one member of the LIMITED PARTNERSHIP must be a general partner and assume
unlimited liability for all debts and liabilities of the business.

The last two types are both treated as corporations in California and provide limited liability for
all "owners". The minimum annual tax is $850 for any corporation doing business in California
(no matter where it is incorporated).

The LIMITED LIABILITY COMPANY and the S-CORPORATION are treated like partnerships
for tax purposes (after payment of the $850 to California). The LIMITED LIABILITY COMPANY
has fewer restrictions on ownership than the S-CORPORATION.

1. PROPRIETORSHIP

ADVANTAGES:
Simple to start.... Nominal legal fee.... Low license fees.... Minimum Government
interference.... Owner is boss.... Profits not shared

DISADVANTAGES:

Terminates with death....

Difficult to raise capital....

Needs diversified talent....

Unlimited liability....

High failure rate

2. PARTNERSHIPS

ADVANTAGES:

Not very difficult to form....

A method of raising capital....

Partners are boss....

Abilities are complemented
SCORE Los Angeles Business Guidance Documents

DISADVANTAGES:

Finding suitable partners....

Disagreements....

Partnership agreement-Legal fees....

Authority of partners undefined....

Unlimited liability....

Difficult to dissolve....

Terminates with death....

Profits shared

3. CORPORATIONS

ADVANTAGES:

A way of raising capital....

Easy ownership transfer....

Limited liability....

Continues until terminated....

Possible tax advantage....

Optional use of sub-chapter S

DISADVANTAGES:

Incorporation costs-Legal fees....

Charter restrictions....

Legal requirements-Reports, records....

More government control....

Franchise tax....

Profits taxed twice

4. S-CORPORATIONS

ADVANTAGES:

Eliminates corporation double taxing

Keeps limited liability advantage of incorporation

Tax is based on partnership returns

Allows pass-through of losses to offset income from other sources

DISADVANTAGES:

All profits must be distributed and taxed annually

If in tax bracket exceeding corporate rate, an S-Corporation may not be desirable

You must incorporate

REQUIREMENTS:

Not over 35 stockholders

A single class of stock

US citizen or resident

Must incorporate and make S-Corp election by filing IRS Form 2553
SCORE Los Angeles Business Guidance Documents
Complexities and tax considerations make it advisable to consult an accountant before electing
for s-corporation treatment

5. LIMITED LIABILITY COMPANIES

WHAT ARE THEY?

Similar to S-Corporations except that LLC's are subject to fewer restrictions

An LLC is treated as a partnership for tax purposes instead of a corporation if it lacks a
majority of the following corporate characteristics:

Limited liability

Continuity of life

Centralized management

Free transfer of interest (ownership)

The new law as written generally makes it not too hard to comply with the above requirements.
In the absence of an agreement to the contrary, the provisions of the statute will automatically
result in the LLC being classified as a partnership.

ADVANTAGES-DISADVANTAGES:

LLC versus a CORPORATION

LLC avoids double taxation

LLC cannot accumulate earnings

LLC not at risk for "unreasonable compensation"

LLC versus an S-CORPORATION

LLC has no restriction on number of shareholders

LLC has more flexibility in allocating profit & loss

LLC versus a GENERAL PARTNERSHIP

LLC partners not personally liable for LLC debts

MORE ADVANTAGES AND DISADVANTAGES:

DISADVANTAGES OF LLC'S

Annual fees are greater than for corporations

A professional service company cannot be an LLC

Restrictions on fringe benefits

LLC'S may face risks of higher taxes and liability for business done in other states

WHO CAN BENEFIT?

New businesses with more than one owner and engaging in a risky business

Analysis of both tax and non-tax considerations is a must before entering into any of the
available entity structures.