The answer is simply that a good business structure will reduce taxes and reduce risk from frivolous lawsuits. Going without a business structure is a risky venture. But, selecting a bad business structure is the riskiest route of all. It will cost you excess tax and waste your time as you are forced to unwind it.

Consider carefully your personal use of business structures before you select the one you want to use. Here’s a summary of business structures you might encounter:

Limited Liability Company
The Limited Liability Company (LLC) is a popular business structure these days. The LLC is not consistently applied in all states. We strongly recommend that you check out the state laws in your area first.

The LLC itself is not a taxing structure. There is no such thing as an “LLC Tax Return.” The LLC can elect to be taxed as any other structure. If no such election is made, a single member LLC will be taxed as a Sole Proprietorship and a multi-owner LLC will be taxed as a General Partnership.

Sole Proprietorship
The Sole Proprietorship is a bad business structure. It will put everything you own at risk and subjects you to an excess tax of 15.3% – self-employment tax – on all net income.

The Sole Proprietorship is reported on a Schedule C of a regular tax return. All of the income is taxable at the individual owner’s personal rate.

When Would You Use a Sole Proprietorship?
I don’t think you should ever use a Sole Proprietorship. This is a business structure that is formed by “default.” If you have a business and don’t form a structure, you are a Sole Proprietorship.

Limited Partnership
A limited partnership (LP) is a good business structure.

A limited partnership has minimum of two partners – a general partner and a limited partner. The general partner is responsible for all actions of the partnership and has full liability. The limited partnership’s risk is limited to the amount of his investment. In other words if a limited partner invested $10,000, the most she could lose would be $10,000.

A limited partnership is a flow-through taxable income. One potential drawback is that the individual partners can have taxable income, if the partnership makes money, even if there is no distribution. This is called “phantom income”, which means that you are a limited partner, with no control, may be required to pay tax on income that flows through to you on paper from the partnership even when there is no cash to accompany it.

The general partner is required to pay self-employment tax on earned income, in addition to the regular federal or state income tax.

A good strategy is to have the general partner position be held by an S Corporation or C Corporation if the partnership will have earned income. If the limited partnership is being used to hold real estate, the general partnership interest could be held by an S Corporation, C Corporation or LLC.

Limited partnership warning: Carefully read any partnership agreements to ensure that distributions are required to cover a portion of attributed partnership income.

When Would You Use a Limited Partnership?
The limited partnership is a great entity to use to hold long-term real estate investments in states where the LLC (limited liability Company) structure isn’t advisable. For example, California has a high annual cost for the LLC. The LP might be a better choice in California.

The limited partnership structure is also used in estate planning. The limited power that limited partners have translates to below fair market value. That means that gifts can be maximized through the use of a limited partnership.

General Partnership
A general partnership is a bad business structure. The general partnership is a default structure that is used when two or more people enter into a joint venture project without a clear business structure.

All general partners of a general partnership will be subject to self-employment tax. Plus each partner is exposed to full liability for acts of any of the other partners as well as risks associated with the business itself.

When Would You Use a General Partnership?
Never use a general partnership.

S Corporation
An S Corporation is a good business structure. It is a regular corporation in which you have made a special election with the IRS to be taxed as an S Corporation. There are some further restrictions as to the number of shareholders and types of shareholders that are allowed. Plus, you have a restricted time period in which you can adopt the S corporation status.

The S corporation provides liability protection to the shareholders against acts of the business. In other words, if something happens within the business, the shareholder’s other assets are safe. It does not protect the business against liability from the business.

Income from the S corporation flows through to the shareholders and is taxed at the individual’s rate. Income from an S corporation is never subject to self-employment tax.

When Would You Use an S Corporation?
An S corporation is an excellent structure to use for a small business that has a loss or has income that doesn’t exceed $30,000 to $50,000. It is also good for professionals who are stuck with the qualified personal service designation (QPS). If you are stuck with QPS designation, you’ll pay extra taxes if you operate as a C corporation. So, the S corporate status makes sense for the QPS designated owners.


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